Monday, February 2, 2015

Deconstructing the S&P 500

Deconstructing the S&P 500: How 36 Stocks Gave You 55% of the S&P's Return in 2014

Like a lot of investors, I watched the S&P 500 Index do very well in 2014, especially compared to holdings in small caps, international, and emerging markets. We own the S&P 500 index as a holding and I'm happy about that.  However, I couldn't help wonder how the S&P did so well. The pundits were decrying the death of active management, and new records on the S&P fell daily as the rest of logical investments sat relatively idle. So, I worked out a trusty spreadsheet with help from friends at Highland Capital, and deconstructed how the S&P did. The results are startling: 36 stocks out of 500 provided over 55% of the total return.

Knowing what the S&P 500 is made up of is important. Essentially, it is an index of 500 stocks selected by the S&P US Index Committee. It's not-contrary to popular belief-the 500 biggest US stocks. The S&P 500 is based on market capitalization, so a big company occupies a much larger portion. Apple, for example, is one stock out of 500, or 0.2% of the total number of stocks, but it is 3.25% of the weight of the index. Apple's return has a very big effect on the overall S&P return (more on this in a minute). WPX Energy is another stock in the S&P 500, but makes up only 0.0058% of the Index. The bigger the company, the more it affects the index and, subsequently, how it performs. Southwest Airlines was the best performing stock in the S&P 500 last year (low oil prices helped, and I suppose they save big on meals), but its only 0.11% of weight of the S&P, so it's 126% return only added .73% to the S&P's total return.

Now for the deconstruction:
  • The top 36 stocks in the S&P 500 provided over 55% of the total return of the S&P for 2014.
  • The top 5 stocks (Apple, Microsoft, Berkshire Hathaway, Intel and Wells Fargo) contributed almost 20% of the total return of the index.
  • Apple by itself contributed 8% of the total index return for 2014, while Exxon contributed a negative 1.17%. Apple contributed almost a third of the total amount from all technology stocks.
  • 35% of the stocks made all of the return for the year.
  • Real estate is only about 2% of the S&P 500, but provided 4.25% of the total return.
  • Energy was an obvious drag.
What's the moral of the story? We all know that diversification is key, but this review should be enlightening.

You only needed 35% of the S&P 500 to get all of your return, but which 35%? It reminds me of a story attributed to John Maynard Keynes, who was asked how many stocks you needed to own. His response was "One".  The interviewer then asked "Which one"? Keynes replied, "The one that makes the most money." The interviewer then asked, "How do I find that one?" Keynes' famous response: "Wish I knew!" So for 2014, you may have loved Apple, but you were really happy with Southwest Airlines (+126.3%). You were probably unhappy with Transocean (-59.9%). But if you owned the whole basket, you owned them all. It's the concept of diversification: have parts of the whole world, and enough to make sure you own the winners.


Wednesday, December 17, 2014

Congress in Action

Congress in Action (err...Inaction)
Alan D. Miller, CPA, PFS
December 17, 2014

In a new show of bipartisanship, the lame-duck Senate finally passed the 'temporary' one-year extension of a hodge-podge list of about 50 tax provisions that had expired at the end of 2013.  The 'tax extender' package retroactively reenacts these tax deductions and credits effective January 1, 2014, but they expire December 31, 2014. The House previously passed a two-year 'extender' package (which included permanent extensions of certain provisions) that, under a threat of a veto by the President, went nowhere in the Senate. Instead, the House passed a one-year extension last week and after some other important business (including funding the government) adjourned and went home for the holidays.  Also wanting to go on vacation (and without the House being in session to consider changes), the Senate voted 74-16 to approve the one-year extension. The President is expected to sign the bill into law this week.

With two weeks remaining in 2014, individuals, families and business owners, along with their tax and financial advisors can finally get to work planning their 2014 tax situations, largely by looking in the rearview mirror. Cheers! Don't forget to save time for year-end holiday activities too!

Most of these provisions were previously enacted temporarily, yet have been extended many times in one form or another, one or two years at a time.  Some offer significant tax breaks to a very narrow constituency (quick expensing of NASCAR race track improvements and race horses) and others offer small benefits to a broader swath of taxpayers (exclusion of up to $250 of classroom supplies purchased by educators). Some offer tax breaks primarily to residents of certain states (deduction of sales tax paid instead of state income tax paid) or for the benefit of retirees and charities (being able to donate IRA withdrawals directly to a charitable organization).

Some were first passed to stimulate the economy during one financial downturn or another (immediate write off of up to $500,000 of equipment purchases by businesses), but due to the fact that there is a very short time for businesses to actually plan for this deduction for the remainder of 2014, they may have limited economic stimulating effects going forward.  Did the owner of the widget factory purchase that 3D widget printer last spring because Congress might allow a juiced-up tax deduction or because her company needed it to keep up with the demand for widgets caused by an improving economy that was already happening?  Other provisions were implemented to reward or encourage specific activities (tax deductions and credits for college expenses or for the purchase of energy efficient property).

Depending on which argument you believe in, each provision either cost the government billions of dollars of revenue or saves taxpayers an equal amount of taxes. The cost/saving of this bill is projected to be $42 billion over 10 years. Regardless of the side you take, there are no doubts these provisions and the question whether they will or will not be an ongoing part of tax landscape add to the complexity of the tax law and to the uncertainty with which individuals and businesses deal in planning their financial activities.

Of the many extended tax provisions, those that have the most potential impact on our clients are summarized below (listed in order of the section of the tax code that is affected):


Deduction for certain expenses of elementary and secondary school teachers

Allows a deduction from adjusted gross income of up to $250 of expenses paid for materials, supplies, technology, etc. for use by an educator in the classroom.

Deduction of mortgage interest premiums as qualified mortgage interest

Treats mortgage interest premiums as mortgage interest expense deductible as an itemized deduction.  This phases out ratably for taxpayers with adjusted gross income in excess of $100,000-$110,000 (half those amounts for married filing separately).

Deduction of state/local sales tax in lieu of state income tax

Taxpayers may elect to deduct as an itemized deduction state/local sales taxes paid (either actual or amount determined based on income) instead of state income taxes paid. (This may be beneficial to retired taxpayers who pay little or no Michigan income tax or residents of a handful of states that do not impose an individual income tax).

Above-the-line deduction for qualified tuition and related expenses

Provides for a deduction from adjusted gross income of qualified college tuition, fees, books, etc. of up to $4,000, depending on adjusted gross income and filing status.

Tax-free distributions from individual retirement accounts for charitable purposes

Allows tax-free distributions from IRAs to charitable organizations of up to $100,000 per taxpayer if at least 70 ½ years old (a married couple may make tax-free distributions of up to $200,000). The amounts contributed in this manner cannot also be deducted as charitable donations.

Credit for purchase of non-business energy efficient property

This provision continues credit of 10% of the cost of certain energy efficient property (furnaces, water heaters, windows, etc.).  The maximum cumulative 'lifetime' credit allowed under this provision is $500.

BUSINESS TAXPAYERS (including individuals with small businesses)

Bonus depreciation

Allows for immediate expensing of 50% of the cost of certain property and equipment placed in service during 2014.

Increased expensing limitations under Sec. 179/treatment of certain real property as Sec. 179 property

Allows for immediate expensing of up to $500,000 of eligible equipment purchases made in 2014; also allows for special treatment of certain real estate purchases as personal property (specifically aimed at retail and food-service businesses).

There are many other provisions with limited applicability to most individual or small business taxpayers.  If you have questions about the items noted above or other extended tax provisions that may affect your specific tax situation please don't hesitate to contact us.

Monday, December 1, 2014

Why We Don't Chase Returns

This year, 2014, has been interesting so far. One major asset class, large US equities, is doing very well, compared to most other asset classes.  That’s great if you own large US equities (and we certainly do!). Having other asset classes, like small cap stocks and emerging markets, can make it trying, since all we ever hear about is the S&P 500 or the Dow. Ever hear the commentator on the news say, “today the MSCI Emerging Market Equity Index was up 1.4% on lower oil prices”?  A question we sometimes get is: ‘Why aren’t we doing as well as the Dow/S&P/NASDAQ?’  Well, two observations:  While we like large US equities, they are not the only asset class.  Small US equities historically have outperformed large US equities. Can you name a large stock that wasn’t once small?  Additionally, international equities provide valuable diversification and real estate is also a good asset class.  Although we can talk about it, it may be just as easy to show, so here’s a chart from JP Morgan:

If you are correctly interpreting the chart, it shows the nine major assets classes (we use them all) and an asset allocation somewhat similar to ours.  So in 2006, REITS, which we have, did stellar (35.1%).  In 2007, they were the worst (-15.7%).  In 2008, cash was second best, and in 2009, cash was worst.  Similarly, in 2008, emerging markets did terribly at -53.2%, followed by being the best performer in 2009 at +79%. The last column shows the annual return of each class.  It’s interesting to note that over 10 years, the asset allocation portfolio did just slightly less than the S&P 500, with considerably less risk (it’s about 35% fixed).

The point of this chart is straightforward:  no single asset class ever dominates the chart, and frequently the top performer slides to the lowest performer.  If you look closely, the light blue ‘allocation’ mix was in the middle-upper portion of the table the entire ten year period, and this holds for longer periods as well. That’s the strategy of asset allocation:  don’t try to hit the ball out of the park, win the game.  And the sweetener?  Rebalance it so that you take profits off the highest asset classes and buy more of the lowest performing asset classes.

One last note:  Cash, as we all know, is not really an investment, but a form of liquidity and a protector.  Note the relative position of cash in the long run.


Thursday, November 6, 2014

What We Think The Elections Are Telling Us

Well, the elections are over and we can now watch attorney ads instead of nasty political ads. In general, the election went as we predicted. The Republicans have taken the largest house majority since WWII and now have the Senate. The question is what does this mean? 

There are two options: the GOP assumes a leadership role and tries to pass legislation (that the president will sign); or continues obstructionist roles. If the obstructionist strategy continues, we will have more brinksmanship and battles. On the other hand, if we get cooperation, a variety of things could happen. A possible outcome is that Paul Ryan will push for tax reform.

The low hanging fruit is corporate reform and repatriation, which would bring billions back into the US for capital expenditures and buybacks. Right now, it is beneficial for corporations to leave their profits abroad rather than bring them home, due to our corporate tax law. Burger King just changed its headquarters to Canada. As my friend Greg Valliere says, "When I say the words 'tax haven' and 'Canada' in the same breath, our tax system is broken." 

The tax extenders, like the qualified charitable distributions from IRAs are likely to pass before year-end. It is unlikely anyone will touch Medicare or Social Security before 2017. Obamacare will still be here, but they may remove the medical device tax and the employer mandate (that depends on Obama's pen). It is unlikely we will see individual tax reform. It sounds good, but everyone will start cobbling on their favorite things: "What about charitable contributions? Mortgage interest? Small businesses?"

Spending is unlikely to increase by any significant measure. Defense spending needs to be maintained, so something will likely happen there. We think Keystone will re-appear, and possibly pass. I am sure out of 535 people, someone in that group will have something to say about Obamacare.

In Michigan, Rick Snyder won re-election and Gary Peters was elected to the Senate. That outcome is interesting because of the party shift. Obviously, a portion of the electorate crossed party lines and voted for the candidates, not necessarily the party. Our prediction is Governor Snyder will continue his current policies of fiscal responsibility, and hopefully address roads, education and jobs. Senator Peters was formerly on the House Financial Services Committee. Both were supporters of the Detroit Grand Bargain. We think the outcome is a 'stay the course' vote in Michigan.

History shows us the very best market situation is a unified congress and lame duck opposition president. In fact, the Republican Senate/House and Democratic president has historically been best for the markets (maybe we remember that one of the only surpluses ever was in the Clinton-Gingrich days). So we are slightly more optimistic. Of course, Congress could just stay obstructionist, which we think enhances Hillary Clinton's position for 2016. One last word: if you have an old car, you might be able to keep your bumper stickers for 2016; you could have Jeb Bush run against Hillary Clinton.


Monday, October 20, 2014

Why we are rebalancing now

Unless you’ve been on a beach without cell phone service (in which case, I envy you), the market is exhibiting a vast amount of volatility and uncertainty.  In today’s world, we can find explanations for everything.  Amongst those is how the drop in oil prices and strong dollar are hurting the market, or that Europe is slowing (I hate to tell Europe, but they have been slow).  We see the glass half-full, and not half-empty.  Here’s why:

 Oil.  Oil prices have “tanked” (down over 20%), which is bad for oil companies and good for everyone else (OK, it’s bad for ISIS, Iran, Iraq and most of the Middle East, but I’m not overly concerned with their financial well-being).  Low crude is a stimulant for the consumer and for profits.  My family spends about $10,000 a year on gas; so a 20% drop in oil prices is like $2,000 in my pocket, tax-free.  Low oil prices are good for consumers and corporate profits.

·         Europe.  Most of the volatility centers around the inaction of Mario Draghi and the European Central Bank (ECB).  The ECB has been too tame in monetary policy, despite many verbal pledges to do whatever it takes.  This may be sending Germany into a recession, and Germany is the strongest EU member.  Greece suffered under the assumption that they may default on their debt.  Not a big surprise since Greece was the first sovereign nation to ever default on their debt in 377 BC and has five debt defaults modern times.  Spain has defaulted 13 times.

·         Talk is cheap. The ECB has been talking but not doing.  This leaves two options:  they can keep doing nothing (which lets the economic march continue), or they can do something (like Quantitative Easing).  A QE type move would probably be good for stocks in Europe.  I’d predict the pressure is on the ECB (and the Chinese Central Bank) to do something, and rather quick.

·         Our economy.  The budget is being cut, unemployment is down, and sentiment is up.  Profits are not terrible, and consumer spending is up along with industrial production.

·         Strong dollar.  The dollar is strong against other currencies.  Why?  Because we are improving our account deficit, booming energy production (hence low crude prices), and reduced unemployment.  Because we are growing, we look good, and it shows.  It also makes imports cheaper, and hurts foreign companies who sell in dollars, but build in other currencies (like Airbus or Swatch).  

·         So why the volatility? I think a bunch of this is the market looking for an excuse.  A few days ago, I joked that the S&P 500 was about to break its 200 day moving average and that it would tank when the program trades kicked in.  It did.

·         Ebola.  Scary stuff.  It’s a horrible disease.  Right now one person has died and two have it in the United States.  So that’s 3 out of 330 million.  In 2010, 53,826 people died of influenza and pneumonia, 576,691 died of cancer and 1 in 700,000 people were struck by lightning.  I offer this as perspective.

·         Factoid on elections.  Interesting fact on mid-terms:  since 1950, there have been 6 calendar years when a Democrat was in the White House and the Republicans controlled the House and the Senate.  The average gain on the S&P 500 during those 6 years was 21.3%. 

What’s our prognosis?  Low oil is good.  Strong dollar is good.  Fundamentals for the US look good.  We believe in capitalism and free enterprise.  If you think owning businesses (stocks) is way to increase wealth, you are right.  So volatility like this requires us to look at the big picture and see if equities are actually vastly worse than they were a month ago, or whether they are merely on sale.  It’s like a big rain storm.  Eventually the sun comes back out.  We choosing to rebalance and take advantage of the opportunity.

If you’d like my commentary on the economy, markets and the elections, I’ll be giving a talk on October 28th at Walsh College at 1:00 and 6:00.  I’ll cover oil, the dollar, gold, stocks, taxes, and whatever else crosses my mind, and will predict that political advertising will decrease abruptly by November 4th (this one I’m sticking by).  If you’d like to join us, RSVP at or 248-641-7400.  Space is limited.


Friday, October 10, 2014

What Goes Up

What goes up…must come down…and up…and down

October of 2014 has been an interesting month so far, just in the first seven trading days.  In seven days, the Dow Jones 30 industrials have moved (up and down) over 1,300 points.  That is significant volatility, especially since the movement tends to oscillate, in an ugly fashion reminiscent of early 2009.  I can’t help but wonder why.  Market movements are of course related to human behavior:  Mr. Market (as Warren Buffet calls the market), can’t make up his mind if he’s bullish or bearish.  Lately, it’s almost an even bounce:  down 270, up 270.  What’s the cause, and what do we do?  We could attribute this to a variety of causes: 

·         Ebola.  Ebola is a significant problem, both from a pandemic standpoint and economic standpoint.  Western African nations stand to lose possibly more than $32 billion of economic growth, just when they were getting out of the woods.  On the other hand, the S&P 500 lost about the same amount on October 9th.  So far, one person has died in the US (out of 330 million people) and three in the EU.  From a global standpoint, the death rate is bad, but it stands at 0.000001% of the world population.  The Ebola outbreak started earlier this year, and the market seemed to shrug it off.  I’ll suggest Ebola is sinister, but maybe not the major fear driver.

·         ISIS.  ISIS is a significant problem, actually more deadly than Ebola.  ISIS has killed, by reports in July, over 5,600 civilians in Iraq alone.  And, like Ebola, ISIS seems to be spreading (and possibly treatable), with a couple of billion dollars, tens of thousands of fighters and some very good (our) military hardware.  However, ISIS has been around for a while, is sinister, but we’ve had bigger and badder opponents. ISIS is a fear driver.

·         North Korea.  Huh?  North Korea?  Haven’t heard anything from them.  That’s exactly the problem.  We haven’t even seen little Kim Jong-un since September 3.  Is he around?

·         Mario Dragi.  Now we may have something.  The head of the European Central Bank (ECB) promised he would take all steps to get the EU out of recession.  However, all steps appear to involve only talking.  The ECB has not engaged in any serious monetary policy (at least compared to the US Fed).  As a result, we’re now seeing signs of weakness in the German manufacturing economy.  Maybe we can remember when the Grecians didn’t have a formula.  Right now, it’s possible the ECB doesn’t have one.  Definite headwind.

·         US Economy.  Back to good news.  The US economy saw a drop in unemployment (down to 5.9%), and the dollar is rising (don’t get too excited: a strong dollar is a double edged sword).  Exports are up, bankruptcies are down.  Business optimism is up, but business confidence is down.  The bellwether consumer confidence is up, as are retail sales and consumer spending. The US economy is providing a nice tailwind.

·         Interest Rates (US).  I only say US because the bond market is kind of silly right now.  The 10-year Spanish bond is at an all-time low yield (a hair over 2%), lower than the US 10-year, which is at a 15-month low.  By way of reference, Spain’s GDP is shrinking at a rate of 1.2%, compared to the US’s growing rate (2.9-4.65%, depending on how you measure it).  Spain’s unemployment rate is 24.5% (versus our 5.9%).  Yet those Spanish bonds are considered lower risk?  The simpler reason is that our Fed is ahead of the European’s, already tapering their bond buying, and trying to get our rates higher, which is good for everybody. (As long as they are not too high).  I’ll say the threat of inflation is modest, compared to the benefits of somewhat higher interest rates.  This is a tailwind.  And think about it:  what sounds better, a Spanish bond paying 2% in euros or a nice global stock paying 3.6% in a dividend in dollars?

·         Elections.  I could say that TV advertising will be off significantly after November 4.  I’ll use the mute button less, but the outcome will probably be rather anticlimactic.  As long as there is rancor in Washington, the sequester forces the deficit to be reduced.  So the infighting is actually good at cutting the budget, albeit not in the way anyone really wants it to be cut.  But, as a wise man once said, “gridlock is good.”  I predict continued gridlock, which means no tax cuts or increases, and less spending. Election results are probably a non-factor.

·         The ‘Orange Car’ syndrome.   There’s a psychological exercise that we find what we look for.  Try it:  for 48 hours, count how many orange cars you see.  You probably never noticed them before (unless you drive an orange car), but now you start looking for them and they appear everywhere.  The last time we had a 10% decline in the S&P 500 was the third quarter of 2011, over 1,100 days ago.  This is on a market that is up 189% off its 2009 lows.  Many investors are waiting for the correction to buy.  And maybe, if you look hard enough for a correction (or an orange car), you’ll find one.  (I saw 38 orange cars in a 48 hour period).

See why the market is getting volatile?  World jitters, behavior, economic data.  But when this happens, recognize that volatility provides the opportunity to rebalance, the opportunity to re-price and more importantly, the opportunity to let markets regroup.  My take is that global GDP is still growing at about 3.3%.  Inaction by the ECB can (and probably will) turn into action.  The US is still continuing to slowly grow, but grow it will.  ISIS and Ebola are sinister, but solvable threats.  The glass is half-full.  Maybe tomorrow it will be half empty.  But note that in my research, all downturns are followed by upturns.  So far, that’s been running at a 100% observation rate.


Tuesday, July 29, 2014

My Buy Michigan Week Contribution

It’s Buy Michigan Week (July 28th through August 3rd), so I’m making my contribution. I’m a Michigan homeboy: I was born in Detroit, grew up in Hazel Park, went to college and law school in Detroit; spend summers in Eastport, hunt in West Branch and kayak any stretch of open water I can find without too many lake freighters. I’ve viewed Michigan as a state of opportunity, and a state where businesses large and small can thrive. Michiganders are survivors: we survive fierce winters, and fierce recessions.

In 2009, I viewed Michigan as an emerging market. We had two of the big three car companies emerging from bankruptcy, plus a plethora of other horrible news. Our unemployment was way over the national average; our real estate markets were devastated. I started tracking Michigan-based companies just by their market capitalization. And guess what? Michigan not only emerged from the ashes, they outperformed the S&P 500 from March 2009 through December 2013 by 25%.

At the end of 2013, I met with the faculty at Walsh College to discuss the finance lab I’m proud to support. Our discussion led to the concept of an emerging market in Michigan and we agreed it would be very cool for the students to have a portfolio of Michigan stocks. I suggested that real money is better than virtual money, so I put up $100,000 of my funds for the students to invest, and the Michigan Alpha Project (MAP) was born.

A student-run team won the request for proposal process to manage the funds. They created an investment policy statement for my account and I gave them access to invest it. How are they doing? Right now, kind of flat. They picked some nice winners, which were offset by some losers. I own a wide spectrum of stock in Michigan businesses, in everything from cars to furniture to high tech and biotech. But I think the students are winning as well, with real-life examples and real money. Hopefully, some of this talent will stay here in Michigan and help our state continue to grow.

So we can ‘Buy Michigan’ in a lot of ways. You can buy a La-Z-Boy chair or La-Z-Boy stock. You can buy a box of Corn Flakes or Kellogg stock (some of the stocks the MAP team picked in my portfolio). In any event, I celebrate our state. We have good companies, great people and bright students. Seems like a good combination.

Si quaeris peninsulam amoenam circumspice