Author: Scott Buchanan

Can Actively Managed Stock Funds Beat the Market?

Scott Buchanan1 Comment

For many people nowadays, investing in “stocks” means buying a fund like SPY or VOO which tracks the large cap S&P 500 index, or maybe QQQ or QQQM which track the tech-heavy NASDAQ 100 index. These types of funds are exchange-traded funds (ETFs), which very low annual fees (around 0.2% or so).  These are so-called passive funds, which mechanically buy and sell stocks such that their holdings match what is in their respective indices. No extra judgment on stock picking is required.

An alternative is to pick stocks yourself, or to buy into a fund with active management, where humans (and their algorithms) try to buy stocks which will beat the passive indices, and try to avoid losing stocks. The active versus passive debate has been going on for decades.  There will always be some active funds that outperform in any given year. These successes help keep the allure of active management alive. On average, though, the performance of active funds (before fees) is generally not much different than the passive funds. Thus, with their added fees, the active funds are net losers.

However, there are always cheerful fund managers with a story on how they have a plan to kill it this year, and there are investors willing to buy those stories. Sometimes these fund managers take financial advisors out for expensive lunches, and, behold, said advisors then recommend these actively managed funds to their clients. And so, there are plenty of active funds that still exist. New ones are minted every year, even as some older ones go out of business.

A problem with benchmarking against a cap-weighted fund like SPY or QQQ is that these passive indices are actually very effective. These work as closet momentum-rewarding funds: as the share price of, say, Microsoft goes up and up (presumably because of accelerating earnings), its representation among the biggest 500 companies (by stock capitalization) goes up. Thus, the better, growing companies automatically keep making bigger contributions to the indices, while fading companies sink to lower and lower per cent weighting. That works well to relentlessly home in on the relatively few stocks that account for the gains of the entire market, and to weed down all those other firms, most of which are net losers on stock price over time.  This algorithm governing the cap weighted funds is tough for active management to beat.

Having stated these challenges, I’d like to compare performance of some actively-managed funds that have shown enhanced performance in recent years. The problem is, of course, we cannot know if this outperformance will continue. But hopefully looking at performance and discussing the underlying strategies of the funds may help investors decide if they would like to participate in any of them.

Two broad categories of stock funds are growth and value. Growth looks at how fast a firm is increasing revenues, earnings, etc. Most tech stocks command high share prices because of their growth prospects, rather than current earnings (although many of the current big tech leaders generate gobs of cash). Value looks at measures such as price/earnings and price/sales and price/book value, hoping to find undervalued firms whose price does not yet reflect the underlying value. Tech funds are generally under-represented in the value category.

Here we will look at five good actively-managed ETFs, and compare total returns (with dividends reinvested) to the S&P 500 fund SPY. They all claim to incorporate both growth and value into their stock picking. These five funds are:

SPGP – This is a supposed “growth at a reasonable price” fund, which seems to weight value more than growth. In top ten holdings, there is only one tech stock, a 2.7% weighting of Nvidia. There are four petroleum companies, and diverse smattering of other types of firms.

GARP – Another “growth at a reasonable price” (note “G.A.R.P.”) fund. This tilts heavily toward growth: seven of the top ten holdings are tech, with 5.43% Nvidia.

PVAL –  As indicated in the name (Putnam Focused Large Cap Value), this is a value fund, but with some growth considerations – –  The top ten are:  Walmart (retail), Exxon Mobil (petro), Thermo Fisher Scientific, Citigroup, Bank of America (finance), Oracle (tech), UnitedHealth Group (healthcare), Coca-Cola, NXP Semiconductors, and PulteGroup (homebuilder).

MOAT – – “VanEck Morningstar Wide Moat”  – This fund seeks to replicate the performance of the Morningstar® Wide Moat Focus Index, which in turn tries to identify a diverse group of U.S. large companies with wide “moats”, that give them sustainable advantages over competitors. Four measures are used to determine a corporation’s dominance: Intangible Assets (brands, patents, proprietary technologies); Switching Costs (inconvenient for the customer to find an alternative); Network Effect (when customers use one service, they adopt additional company services); Cost Advantage.

FFLC – This fund uses “fundamental analysis” and looks for companies that can take advantage of trends in “technological advances, product innovation, economic plans, demographics, social attitudes, and other factors”. An analysis of the fund’s holdings (heavy in big tech; 6% Nvidia) shows a strong focus on growth and momentum, with a moderate value weighting.

All these funds have plausible rationales for choosing the stocks they do. A big question is always: how much of a company’s promise is already reflected in its stock price? If everyone else has already figured out that, say, Microsoft will have high sustained earnings growth, then maybe the current share price is so high that it will not go up any faster than the broad market.

Now for the charts. I will discuss 1-year, 3-year, and 5-year charts, so we can see how the fund strategies worked in different market regimes. The one-year chart covers the raging bull market of the past twelve months, especially in AI-related tech/growth stocks. The 3-year chart encompasses a lengthy bear episode that occupied most of 2022, in reaction to the raising of interest rates to tamp down inflation. The 5-year chart includes the brief but sharp pandemic panic March-April 2020, sandwiched in a huge rise in internet-related big tech stocks 2019-2021.

One-Year Chart

Over the past one year, GARP (52% return) soared way above S&P 500 (blue line, 39%), but with high volatility, consistent with its heavy growth/tech exposure. FFLC steadily pulled ahead of SP500 over the past twelve months, racking up a 47% return. PVAL and MOAT finished close to SP500, while tech-poor SPGP flat-lined in the most recent six months and so got left far behind.

Three-Year Chart (End Oct 2021-end Oct 2024)

The defining features of the past three years were a roughly 21% bear market decline in S&P 500 during Jan-Oct 2022, followed by a strong recovery, which was interrupted by a moderate slump July-Oct 2023.    FFLC and PVAL performed nearly identically for the first third of this time period (through early March, 2023). They dropped much less than SP500 in 2022, and so by early March, 2023 they were some 15% ahead of SP500. PVAL’s lead over SP500 shrank a bit over the next twelve months, and then widened March-July 2024, to give PVAL (43%) a 16% advantage over SP500 (27%) at the end of three years.  FFLC just kept steadily widening its lead over SP500, ending with a 58% return over this three-year time period. MOAT and SPGP also fell less than SP500 in 2022, but fell more than PVAL and FFLC, and they did not keep pace with the tech-led surge in 2023-2024. In the end, MOAT finished essentially even with SPY, and SPGP finished lower (18%). Tech-heavy GARP crashed harder than SP500 in 2022, but more than made up for it with the 2024 tech-fest, finishing well above SP500 and tied with PVAL at 43%.

I won’t show the full five-year chart, since some of the funds did not start prior to that period. But I will make a few semi-quantitative comments. The five-year time period is a little kinder to SPGP – this fund showed a fairly consistent lead over SP500 in 2021 as well as 2022, and so got rave reviews then in the investing literature. It was only in the past six months that it performed so poorly.

FFLC got off to a rocky start, falling about 10% behind SP500 in 2020-2021, although its winning ways since then gave it the overall best 5-year performance. GARP and MOAT pretty much kept pace with SP500 Oct 2019-Oct 2021, so their five-year performance vs SP500 is about the same as for three-year (GARP soundly beat SP500, MOAT roughly tied).

One more chart (below), a five-year comparison of SP500 to FFLC (overall winner among the active funds discussed above) and GARP (tech-heavy) to QQQ (passive, tech-heavy, tracks NASDAQ 100 stocks) and SSO (its stock price moves up and down 2X the daily price movement of S&P500). GARP didn’t start operation till early 2020 (marked by red arrow on chart), to its curve should be shifted up to make a fair comparison with the others; with this correction, it would end up roughly tied with FFLC, with both these funds beating SP500 by about 33% (135% return vs 92%). But even these stellar active funds were soundly beaten by QQQ and even more by the passive 2X fund SSO. Holders of SSO, however, would have suffered heart-stopping drawdowns along the way (e.g. over 50% loss in market value in early 2020).

Readers can draw their own conclusions from this flyover of results. Just like you can fool people some of the time, any active fund may beat “the market” (e.g., S&P 500) some of the time. Some active funds seem to beat the market most of the time. But it is most unlikely that any given fund will beat it all of the time. The S&P 500 algorithm is actually pretty effective. It may behoove the investor to make their own judgement as to what market regime we are in or are about to be in, and to choose active funds which are more likely to thrive in that regime.

I am motivated to include some FFLC (for overall consistent good performance) and PVAL (for a bit of crash protection) in my holdings. But I recognize that their performance could deteriorate in the future, if their investing style no longer works in some new market regime. SPGP is a cautionary example, going from rock star in 2021-2022 to awful in 2024. Even FFLC had an unfavorable first year of operation. The tech giants that dominate QQQ continue to also dominate earnings growth, so QQQ may continue to outpace SP500.

As far as SSO, I earlier wrote on strategies for 2X returns using 2X funds or call options. If you think stocks are going to keep going up, it can make sense to hold these 2X funds. Many advisors, though, recommend against just buy and hold because of the enormous possible losses in a crash; too many investors panic and sell at a low price in that situation. I hold some QLD, which is a 2X QQQ fund, but only as a minor component of my portfolio. Also, if I can overcome fear in the moment, I plan to swap out of plain vanilla stock funds and into a 2X fund like SSO after the next big dip in the market, and then swap back out of SSO after the market recovers.

Disclaimer: Nothing here should be considered advice to buy or sell any security.

The Bulls Speak: Reasons Why Stocks Will Keep Going Up

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I focus much of my investing energy in the “high yield” area, finding stocks that pay out highish yields (8-12%, these days). Unless the company really hits hard times and has to cut its payout, I know I will make those returns over the next twelve months. But with ordinary stocks, you cannot count on any particular returns. The price of any stock a year from now will be the earnings per share (which can be forecasted with some degree of accuracy) times the price/earnings ratio, which is largely dependent on the emotions (“animal spirits”, in the words of Keynes)  of the millions of market participants. Will I find a “greater fool” to buy my Amazon stock in a year for 20% more than I paid for it??

I have never gotten really comfortable with that as an investing model, and so I have erred on the side of caution and generally held less than the recommended 60% or so of my portfolio in plain stocks. In hindsight, that was a mistake. Every $10,000 put into the plain, dumb S&P500 fund SPY twenty years ago has turned into roughly $200,000. One reason for my caution has been a steady stream of articles that always warn that stocks are overvalued; after going up so much in the past X years, surely returns will be poor for the next several years.

But I try to learn from my mistakes, and I am now forcing myself to hold more equities than I “feel” like. To support this hopefully rational behavior, I am paying more attention to articles that present bull cases for stocks. One author on the Seeking Alpha investing site who has been consistently and correctly bullish for the past two years is Lawrence Fuller. Here I will summarize his Oct 9 article with the tongue-in-cheek title Be Afraid, Be Very Afraid. (To read articles on Seeking Alpha, you may have to start a free account, where you just have to give them an email address; I use my secondary “junk” email for these sorts of applications, which tend to send a lot of junky (not malicious) notifications).

He first addressed the angst that says, “Stocks have already run up so much, they are due for a crash”, by means of this chart showing cumulative returns in preceding bull markets:

It is obvious that, compared to the average bull market, we are still in early innings with the present bull which started in Oct 2022.

Fuller also makes the case that the good news on earnings has spread recently from the so-called Magnificent Seven big tech stocks (Microsoft, Apple, Nvidia, etc.) to the broader market. This should serve to support further price rises in the broad indices:

The chart below, which shows a similar story, in terms of net income growth:

He concludes:

“It is also important to recognize that the valuation of the S&P 500 is far more reasonable when we exclude the exceedingly expensive Magnificent 7 and focus on the remaining 493. In fact, we don’t have the valuation problem that bears purport we have today. Hence, I advised investors to avoid the market-cap-weighted indexes and focus on equal weight or look at sectors that had been left behind during the bull market to date…Therefore, I suggest not succumbing to fear. Instead, focus on whether the weight of evidence suggests we should be in wealth accumulation mode or wealth preservation mode.”

In a follow-up article, Are You Worried About An Overvalued Market? , Fuller notes that small cap stocks (as defined by the Russel 2000 index, which is held by the IWM fund) are more reasonably valued than big tech, and so are likely to outperform over the next year.

For another bullish perspective, see Why Economic Data Is About To Get Ugly And 3 Things Investors Need To Know, by Dividend Sensei. He notes the robust growth of GDP and of corporate earnings, which can justify a seemingly high price/earnings ratio. The article summary points are:

  • Economic data will appear alarming due to hurricane impacts, but the economy is growing at 3% with strong corporate profit prospects and low recession risk.
  • Inflation is on track to fall to 1.8% by May, with real wage growth outpacing pre-pandemic trends. Future inflation is expected to remain stable at 2.1% over the next 30 years.
  • Market valuation is not as overvalued as feared, with potential for significant upside (up to 30% to 38%) based on corporate profit growth and falling interest rates.
  • Short-term market volatility is normal; long-term investors should embrace corrections for potential high returns as fundamentals remain strong.
  • The average 2-year return after a 10+% correction is 35%, meaning long-term investors should embrace corrections as wonderful buying opportunities. Buy with confidence in the face of any short-term market weakness, as long as you stick to your optimal personal asset allocation, based on your specific risk profile and financial needs.

This article has a number of interesting and informative sections, including on why cash flow/enterprise value is a better metric for assessing the valuation of a stock than price/earnings.

Bonkers BBC Weather App: 18,995 mile/hour Winds in U.K.

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Last week as the U.S. National Weather Service was warning Florida residents of incoming 120 mile/hour winds, folks in the U.K were informed by the BBC weather app that the wind speed outside was – – wait for it – – 18,995 mph.  Hurricane force winds were displayed for many cities worldwide. Not to mention temperatures of around 400 F for Nottingham, New York, and Sydney.

The BBC of course issued retractions and apologies, blaming a third-party data supplier. Said supplier, meteorological forecasting company DTN has apologized for what it called a “technical error”.

I had my Brave browser do an AI search/summary on the topic, “What measures does the BBC take to prevent or mitigate the impact of third-party supplier issues on its weather forecasting app?”. Here is what it told me:

Based on the provided search results, the BBC takes the following measures to prevent or mitigate the impact of third-party supplier issues on its weather forecasting app:

  • Diversified data sources: The BBC uses multiple data suppliers, including MeteoGroup, to ensure that its forecasts are accurate and reliable. This diversification helps to reduce dependence on a single supplier and minimizes the impact of issues with a particular supplier.
  • Real-time updates: The BBC’s weather app provides real-time updates, which enable it to quickly respond to and correct any errors or inaccuracies caused by third-party supplier issues.
  • Error detection and correction: The BBC’s weather experts closely monitor forecasts and are able to detect and correct errors or inaccuracies caused by third-party supplier issues.
  • Technical redundancy: The BBC has implemented technical redundancy measures, such as backup systems and fail-safes, to minimize the impact of third-party supplier issues on its weather forecasting app.
  • Collaboration with other organizations: The BBC collaborates with other organizations, such as the Met Office and Scottish airline Loganair, to improve forecast accuracy and mitigate the impact of third-party supplier issues.
  • Investment in technology and AI: The BBC invests in advanced technology and artificial intelligence to improve the accuracy and reliability of its weather forecasts, reducing the reliance on third-party suppliers and minimizing the impact of issues.
  • Monitoring and maintenance: The BBC regularly monitors and maintains its weather forecasting app and underlying systems to identify and address potential issues before they become critical.

These measures demonstrate the BBC’s proactive approach to mitigating the impact of third-party supplier issues on its weather forecasting app, ensuring that users receive accurate and reliable forecasts.

That all sounds great in theory, but in practice something failed last week. I guess there is so far no fool-proof substitute for having a pair of human eyeballs look at material before it is flung out into cyberspace. But that might cost money.

Nobody is saying, but it would not surprise me if the BBC adds yet another layer of auto-checking to its robo-forecasts, to at least flag physically unrealistic numbers.

The Dietary Salt Wars

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For many years, it has been stated as settled science that Americans need to cut back their sodium intake from the current averages of about 3400 mg/day to less than  2400 mg sodium (about 1 teaspoon of table salt). The 2400 mg figure is endorsed by the National Academies, as described in the 164-page (we’re from the government and we’re here to help) booklet Dietary Guidelines for Americans published by USDA and HHS. The reason given is that supposedly there is a roughly linear relationship between salt intake and blood pressure, with higher blood pressure correlating to heart disease. The World Health Organization (WHO) recommends less than 2000 mg.

The dietary salt boat has been rocked in the past several years by studies claiming that cutting sodium below about 3400 mg does not help with heart disease (except for patients who already incline toward hypertension), and that cutting it much below 2400 mg is actually harmful.

The medical establishment has come out swinging to attack these newer studies. A 2018 article (Salt and heart disease: a second round of “bad science”? ) in the premier British medical journal The Lancet acknowledged this controversy:

2 years ago, Andrew Mente and colleagues, after studying more than 130000 people from 49 different countries, concluded that salt restriction reduced the risk of heart disease, stroke, or death only in patients who had high blood pressure, and that salt restriction could be harmful if salt intake became too low. The reaction of the scientific community was swift. “Disbelief” was voiced that “such bad science” should be published by The Lancet.  The American Heart Association (AHA) refuted the findings of the study, stating that they were not valid, despite the AHA for many years endorsing products that contain markedly more salt than it recommends as being “heart healthy”.

This article went on to note that, “with an average lifespan of 87·3 years, women in Hong Kong top life expectancy worldwide despite consuming on average 8–9 g of salt per day, more than twice the amount recommended by the AHA recommendation. A cursory look at 24 h urinary sodium excretion in 2010 and the 2012 UN healthy life expectancy at birth in 182 countries, ignoring potential confounders, such as gross domestic product, does not seem to indicate that salt intake, except possibly when very high, curtails lifespan.”

A more recent (2020) article by salt libertarians, Salt and cardiovascular disease: insufficient evidence to recommend low sodium intake, stated in its introduction:

In 2013, an independent review of the evidence by the National Academy of Medicine (NAM) concluded there to be insufficient evidence to support a recommendation of low sodium intake for cardiovascular prevention. However, in 2019, a re-constituted panel provided a strong recommendation for low sodium intake, despite the absence of any new evidence to support low sodium intake for cardiovascular prevention, and substantially more data, e.g. on 100 000 people from Prospective Urban Rural Epidemiology (PURE) study and 300 000 people from the UK-Biobank study, suggesting that the range of sodium intake between 2.3 and 4.6 g/day is more likely to be optimal.

… In this review, we examine whether the recommendation for low sodium intake, reached by current guideline panels, is supported by robust evidence. Our review provides a counterpoint to the current recommendation for low sodium intake. We suggest that a specific low sodium intake target (e.g. <2.3 g/day) for individuals may be unfeasible, have uncertain consequences for other dietary factors, and have unproven effectiveness in reducing cardiovascular disease. We contend that current evidence, despite methodological limitations, suggests that most of the world’s population consume a moderate range of dietary sodium (1–2 teaspoons of salt) that is not associated with increased cardiovascular risk, and that the risk of cardiovascular disease increases when sodium intakes exceed 5 g/day.

The keepers of orthodoxy fired back the following year in an article with an ugly title Sodium and Health: Old Myths and a Controversy Based on Denial  and making ugly accusations:

Some researchers have propagated a myth that reducing sodium does not consistently reduce CVD but rather that lower sodium might increase the risk of CVD. These claims are not well-founded and support some food and beverage industry’s vested interests in the use of excessive amounts of salt to preserve food, enhance taste, and increase thirst. Nevertheless, some researchers, often with funding from the food industry, continue to publish such claims without addressing the numerous objections.

Ouch.

I don’t have the expertise to dig down and make a ruling on who is right here. But I do feel better about eating my tasty salty chips, knowing I have at least some scholarly support for my habit.

Herd Mentality Among Pediatricians Caused Current Peanut Allergy Epidemic

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A headline, “How Pediatricians Caused the Peanut Allergy Epidemic” got me to click the other day. The article makes some important points, I think.

Having a peanut allergy is a serious health concern, both as an adult and for one’s child. For a sensitized person, exposure to peanut-containing products can be fatal if an Epi-pen or emergency room is not available for an epinephrin injection. Since this is an economics blog, I’ll note that a 2012 survey estimated the economic cost of any food allergy in US children at $24.8 billion annually, or $4184 per child. This includes direct medical costs, and the indirect costs, including opportunity costs, for children and their caregivers.

Out of an abundance of caution, pediatricians in the 1990s started recommending that parents keep peanuts from their infants and children. Instead of protecting children, however, this policy has done just the opposite. The incidence of peanut allergies has soared, with now some 2.5% of the pediatric population showing peanut allergies:

Around the year 2000 peanut allergies began to skyrocket. Sales of EpiPens, used in cases of peanut-induced anaphylactic shock, became a major expense for parents and a growing profit center for the manufacturer. … So, what changed? How did peanuts go from cheap, nutritious food source to become the little death pills that we think of them today? The answer is not what you would expect: pediatricians created the peanut allergy epidemic.

Meanwhile, the more that health officials implored parents to follow the recommendation, the worse peanut allergies got. From 2005 to 2014, the number of children going to the emergency department because of peanut allergies tripled in the U.S. By 2019, a report estimated that 1 in every 18 American children had a peanut allergy. 

It did not have to go like this.  I poked about the web and found another article, titled The Medical Establishment Closes Ranks, and Patients Feel the Effects, which framed matters in terms of physician behaviors:

 Peanut allergies in American children more than tripled between 1997 and 2008, after doctors told pregnant and lactating women to avoid eating peanuts and parents to avoid feeding them to children under 3. This was based on guidance issued by the American Academy of Pediatrics in 2000.

You probably also know that this guidance, following similar guidance in Britain, turned out to be entirely wrong and, in fact, avoiding peanuts caused many of those allergies in the first place.

That should not have been surprising, because the advice violated a basic principle of immunology: Early exposure to foreign molecules builds resistance. In Israel, where babies are regularly fed peanuts, peanut allergies are rare. Moreover, at least one of the studies on which the British advice was based showed the opposite of what the guidance specified.

As early as 1998, Gideon Lack, a British pediatric allergist and immunologist, challenged the guidelines, saying they were “not evidence-based.” But for years, many doctors dismissed Dr. Lack’s findings, even calling his studies that introduced peanut butter early to babies unethical.

When I first reported on peanut allergies in 2006, doctors expressed a wide range of theories, at the same time that the “hygiene hypothesis,” which holds that overly sterile environments can trigger allergic responses, was gaining traction. Still, the guidance I got from my pediatrician when my second child was born that same year was firmly “no peanuts.”

It wasn’t until 2008, when Lack and his colleagues published a study showing that babies who ate peanuts were less likely to have allergies, that the A.A.P. issued a report, acknowledging there was a “lack of evidence” for its advice regarding pregnant women. But it stopped short of telling parents to feed babies peanuts as a means of prevention. Finally, in 2017, following yet another definitive study by Lack, the A.A.P. fully reversed its early position, now telling parents to feed their children peanuts early.

But by then, thousands of parents who conscientiously did what medical authorities told them to do had effectively given their children peanut allergies.

This avoidable tragedy is one of several episodes of medical authorities sticking to erroneous positions despite countervailing evidence that Marty Makary, a surgeon and professor at Johns Hopkins School of Medicine, examines in his new book, “Blind Spots: When Medicine Gets It Wrong, and What It Means for our Health.”

Rather than remaining open to dissent, Makary writes, the medical profession frequently closes ranks, leaning toward established practice, consensus and groupthink.

This article describes further instances of poorly-founded medical advice. Women were scared away from helpful estrogen hormone replacement therapy for many years because of unfounded fears of breast cancer. Blood donor institutions suppressed concerns about AIDS in donated blood, in order to not rock the boat:

In 1983, near the beginning of the AIDS crisis, the American Red Cross, the American Association of Blood Banks and the Council of Community Blood Centers rejected a recommendation by a high-ranking C.D.C. expert to restrict donations from people at high risk for AIDS. Instead, they issued a joint statement insisting that “there is no absolute evidence that AIDS is transmitted by blood or blood products.” The overriding concern was that Americans would not trust the blood supply, or donate blood, if people questioned its safety.

As with the advice on peanuts, a reversal came about far later than it should have. It took years for the blood banking industry to begin screening donors and it wasn’t until 1988 that the F.D.A. required all blood banks to test for H.I.V. antibodies. In the interim, half of American hemophiliacs, and many others, were infected with H.I.V. by blood transfusions, leading to more than 4,000 deaths.

That is poignant for me, since a good friend of mine died from AIDS that he contracted through a blood transfusion in that timeframe.

Well, what to do now about peanuts? It seems an obvious action is to expose infants to peanuts, at 4-6 months, along with other solid foods – – perhaps with the caveat to start with small doses and preferably stay within driving distance of an emergency room should that be needed. As for children who now manifest peanut allergies, there is some hope of desensitizing them if you start young enough, preferably no more than three years old.

Did Sherlock Holmes Really Wear a Deerstalker Hat?

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Quick, who is the guy on the right in the illustration below?

Image: YouTube

Here he is again:

We’d know him anywhere, thanks to that deerstalker cap. This was a practical hat used by hunters and other outdoorsmen in England at the time. It was popular with women as well as men. The front and back brims warded off rain and sun. The ear flaps tied under the chin for cold weather or wind. The flaps were tied at the top when they were not down. Holmes’s hat was apparently in a hounds-tooth tweed pattern of water-shedding wool.

How often did Arthur Conan Doyle feature his detective character wearing this headgear? Actually, he didn’t at all. The stories never once mention Holmes in a deerstalker cap (or an Inverness cape, another Sherlock Holmes trope), although such a hat is not implausible.

When the first sets of Sherlock Holmes stories appeared serialized in the Strand magazine in the early 1890’s, they were illustrated by artist Sidney Paget. Paget is responsible for the deerstalker cap image. Here is the detective and his sidekick on the way to investigate the Boscombe Valley mystery:

Image: Wikipedia The Boscombe Valley  Mystery   

It would seem that Sherlock Holmes lived and died by his deerstalker, as evidenced by Paget’s illustration on the detective’s struggle to the death with the arch-villain Professor Moriarity above Reichenbach Falls, in The Final Problem:

Image: Wikipedia

( Doyle wrote The Final Problem to kill off his detective character, so the author could move on to more dignified pursuits than writing Sherlock Holmes stories. He did not anticipate the public outcry at the demise of the popular character. Men in London wore black armbands, and subscriptions to the Strand magazine were cancelled in protest. Eventually Doyle brought Holmes back in a further series of stories, with the literary device that Holmes had faked his own death in order to hide out from a criminal syndicate. )

Even Paget did not keep Holmes in this hat all the time. When the great detective was not sleuthing in the outdoors, he was properly dressed for English society. It was unthinkable for a gentleman to appear in public without some kind of hat. For instance, here are two illustrations from The Adventure of Silver Blaze. Holmes is depicted below in his deerstalker when confronting a bad guy at the gate of a neighboring farm, after tracking a horse across the moor:

In the same story, however, Holmes is drawn by Paget at a horse race event wearing a formal top hat like the other gentlemen:

Image:  Wikipedia    Holmes with Silver Blaze (forehead dyed), 1892 illustration by Sidney Paget

If all this leaves you itching for your own deerstalker cap, there are several versions available on Amazon, e.g. here and here. 

Bonus: if you yearn to identify with a more contemporary hero, see here for info on Indiana Jones fedoras.

Easter Island Ecological Collapse Debunked

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Jared Diamond is a polymath (biochemistry, physiology, ornithology, ecology; MacArthur Genius Grant; etc.) perhaps best known for his Guns, Germs and Steel (1997). In that book (which I read) he proposed that shared learnings and practices across the vast Eurasian continent led to optimized food crops and agricultural practices for Eurasian peoples, which in turn led to dense, stratified societies where technical development could progress. This included Chinese and other Asian societies, not just Europeans. This enabled large military forces equipped with formidable weapons, that could dominate non-Eurasian peoples when they came in contact. The rest is history.

In another popular book (which I also read), Collapse: How Societies Choose to Fail or Succeed (2005), Diamond presented explanations for the collapse or (relative) failure of a number of modern and historical societies. These included the Norse settlers in Greenland, the Maya of Central America, and Easter Island.

Easter Island, known as Rapa Nui by its natives, is the most isolated inhabited landmass on Earth. It lies some 2200 miles west of Chile and 1200 miles east of Pitcairn Island (think: mutiny on the Bounty). The first European contacts were brief visits by various ships in the early 1700’s.  At that point, there appeared to be several thousand inhabitants, and no large trees. It seems that Polynesian settlers arrived on the island around 1200 A.D., though perhaps as early as 800. The pollen record and carbon-14 dating showed that large palm trees were present on the island, but disappeared around 1650.

Easter Island is perhaps best known for its many large (20-30 ft high) stone carvings called moai:

Image: Wikipedia

Scholars have supposed that a large, hierarchical society was needed to produce the some 1000 moai observed on Easter Island.  These statues were later deliberately toppled, for reasons unknown.

Following the suggestions of some early anthropologists, Diamond spun a riveting apocalyptic tale of overpopulation and stupidity: supposedly the population grew to some 15,000 souls, mindlessly chopping down all the trees to transport and erect the huge stone carvings.  This deforestation, together with exhaustion of nutrients in the soil, led to a downward spiral in the welfare of the community: no trees = soil erosion and water runoff and no edible nuts;  no wood= no boats = few fish. Shifts in trade winds or climate were also implicated. Tribal warfare, class struggle and cannibalism erupted, with mass deaths through violence and starvation, all before the Europeans showed up. The account of internecine conflict was supported by the natives’ oral traditions.  This whole story arc was taken to be a parable for our times: if you mess with your ecosystem, society may not stand the strain.

Perhaps jealous of upstart Jared Diamond’s success, some fifteen authors from the professional anthropology guild ganged up and published an attack volume titled Questioning Collapse in 2009. They disputed many of Diamond’s assertions, including his Easter Island collapse scenario.

Results from the past several years have swung the consensus firmly against the ecocide collapse theory. For instance, a carbon-14 dating study of bone and wood artifacts by DiNapoli, et al.  indicated a steady growth in population up until European contact in the early 1700s. The same conclusion was reached in a recent study by  J. Víctor Moreno-Mayar et al., using DNA measurement from native genomes dating between 1670 and 1950. Also, it seems from mariners’ reports that toppling of the statues did not begin until after European contact. The loss of the trees is now attributed mainly to the Polynesian rats brought with the natives; the rats eat the palm seeds.

What actually did the natives in was a series of raids by Peruvian slave-traders in 1862. They abducted about half of the 3000 inhabitants, including the leaders and cultural carriers. After a public outcry o\in 1865 by the bishop of Tahiti, the embarrassed Peruvian government repatriated the surviving slaves, but they carried back a smallpox infection which killed off most of the rest. “1868 saw the entire social order of Easter Island collapse, there were no more standing Moai statues… In 1877, only 110 impoverished and disheartened inhabitants remained.” Ouch. So, the social order did collapse, but not from climate change or ecological stupidity.

In 1888, Chile took over Easter Island as a protectorate, shielding the inhabitants from further slaver attacks. That began a fitful recovery for the Rapa Nui people, who as of 2017 numbered 3,512. This is roughly the population prior to European contact.

How Many People Think the Earth is Flat, and Doesn’t Move?

Scott Buchanan2 Comments

Most of us have read or heard references to flat-earthers. I have always assumed they are some tiny tongue-in-cheek group which is just playing out an elaborate joke on the rest of us. The Greeks figured out by 300 A.D. that the earth was round, and this tidbit was incorporated into medieval scholarship, so there has never been much religious or traditional impetus for a flat earth. I was therefore a bit surprised to learn that flat earth beliefs are very serious to many folks, and that such beliefs seem to be on the rise.

From Wikipedia:

In 2020, it was reported that based on polling by Datafolha, 7% of Brazilians believed in a flat Earth. A 2018 YouGov poll found that around 4% of the population of the United States believed in flat Earth while the POLES 2021 Survey found around 10% of the United States population believed that the Earth is flat. A 2019 YouGov survey found that around 3% of British people supported flat Earth.

Digging into that 2018 YouGov poll finds that 2% of Americans resolutely say the earth is flat, but many others who lean towards a round earth are not quite sure. Flat-earthism is more prevalent in Millennials than in older folks, only 66% of Millennials firmly believe the earth is round :

While an overwhelming majority of Americans (84%) believe that the Earth is round, at least 5% of the public say they used to believe that but now have their doubts.
Flat earthers find traction in their beliefs among a younger generation of Americans. Young millennials, ages 18 to 24, are likelier than any other age group to say they believe the Earth is flat (4%).

Apparently, a YouTube channel launched in 2015 by real-life pinball wizard Mark Sargent (“…a competitive video game player, winning one virtual pinball tournament”), which has amassed over two million views, has played a role in popularizing flat earth beliefs. In his brand of geography, the center of the earth-disk is roughly the North Pole, and the edge of the earth-disk lies in what we normally think of the extreme south, and is surrounded by an ice-wall. Several basketball players (Kyrie Irving, Wilson Chandler, Draymond Green) and a rapper (B.o.B) have come out in favor of flatness. The NASA conspiracy of a round earth is crumbling…

 I think some of this flat-earth polling is just ignorance, especially those who are not sure. But there are those who “have their reasons”, often citing various (pseudo) scientific arguments to support their beliefs:

Research by Carlos Diaz Ruiz and Tomas Nilsson on the arguments that flat Earthers wield, shows three factions, each one subscribing to its own set of beliefs.

The first faction subscribes to a faith-based conflict in which atheists use science to suppress the Christian faith. … their arguments use the Scripture – word-by-word – to support an argument that enables God to really exist.

The second faction believes in an overarching conspiracy for knowledge suppression. Building upon the premise that knowledge is power, the flat Earth conspiracy argues that a shadowy group of “elites” control knowledge to remain in power. In their view, lying about the fundamental nature of the Earth primes the population to believe a host of other conspiracies. …

The third faction believes that knowledge is personal and experiential. They are dismissive of knowledge that comes from authoritative sources, especially book knowledge. 

Belief in geocentricity (i.e., that the earth is stationary and the sun goes around the earth) is even more widespread than belief in a flat earth. From Wikipedia:

According to a report released in 2014 by the National Science Foundation, 26% of Americans surveyed believe that the Sun revolves around the Earth.  Morris Berman quotes a 2006 survey that show currently some 20% of the U.S. population believe that the Sun goes around the Earth (geocentricism) rather than the Earth goes around the Sun (heliocentricism), while a further 9% claimed not to know. Polls conducted by Gallup in the 1990s found that 16% of Germans, 18% of Americans and 19% of Britons hold that the Sun revolves around the Earth.  A study conducted in 2005 by Jon D. Miller of Northwestern University, an expert in the public understanding of science and technology,  found that about 20%, or one in five, of American adults believe that the Sun orbits the Earth.  According to 2011 VTSIOM poll, 32% of Russians believe that the Sun orbits the Earth.

Geocentrism seems particularly driven by religious concerns, although I think the polls also heavily reflect plain ignorance. There are passages in the Bible which, if taken literally, seem to mandate a stationary earth and a moving sun. The Roman Catholic church has tiptoed away from its condemnation of Galileo four hundred years ago, and essentially accepted his contention that such passages were never intended to be taken literally. Nevertheless, Catholic layman Robert Sungenis has vigorous argued for geocentricity and Bible literalism, publishing books such as Galileo Was Wrong. On the fundamentalist Protestant side, there is the Association for Biblical Astronomy, with its web site www.geocentricity.com. They make arguments to dismiss the usual scientific conclusions on this matter.

Geocentricity is somewhat poignant for me, because a good friend of mine from college later became deeply attached to it, to the point that he rejected my thinking as apostate when I disagreed. He was a bright guy and an Ivy League graduate. Which just goes to show that fringe beliefs can have unexpected appeal.

Charles Hugh Smith: Six Reasons the Global Economy Is Toast

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If you are feeling OK about the world after a nice Labor Day weekend, I can fix that. How about six reasons why global economic growth will slow to a crawl, courtesy of perma-bear Charles Hugh Smith?

Smith is recognized as an earnest, good-willed alternative economic thinker. His OfTwoMinds blog and other publications bring out many valid facts and factors. He has been extrapolating from those factors to global financial collapse for well over fifteen years now, growing out of the imminent peak oil movement of circa 2007 vintage and the scary 2008-2009 financial crisis. Obviously, he has continually underestimated the resilience of the national and global systems, especially the ability of our finance and banking folks at keeping the debt plates spinning, and our ability to harness practical technology (e.g. fracking for oil production). Smith recommends preparing to become more self-reliant: we should learn more practical skills, and prepare to barter with local folks if the money system freezes up.

For now, I will let him speak for himself, and leave it to the readers here to ponder countervailing factors. From August 11, 2024, we have his article titled, These Six Drivers Are Gone, and That’s Why the Global Economy Is Toast:

The six one-offs that drove growth and pulled the global economy out of bubble-bust recessions for the past 30 years have all reversed or dissipated. Absent these one-off drivers, the global economy is stumbling off the cliff into a deep recession without any replacement drivers. Colloquially speaking, the global economy is toast.

Here are the six one-offs that won’t be coming back:

1) China’s industrialization.

2) Growth-positive demographics.

3) Low interest rates.

4) Low debt levels.

5) Low inflation.

6) Tech productivity boom.

( 1 ) Cutting to the chase, China bailed the world out of the last three recessions triggered by credit-asset bubbles popping: the Asian Contagion of 1997-98, the dot-com bubble and pop of 2000-02, and the Global Financial Crisis of 2008-09. In each case, China’s high growth and massive issuance of stimulus and credit (a.k.a. China’s Credit Impulse) acted as catalysts to restart global expansion.

The boost phase of picking low-hanging fruit via rapid industrialization boosting mercantilist exports and building tens of millions of housing units is over. Even in 2000 when I first visited China, there were signs of overproduction / demand saturation: TV production in China in 2000 had overwhelmed global and domestic demand: everyone in China already had a TV, so what to do with the millions of TVs still being churned out?

China’s model of economic development that worked so brilliantly in the boost phase, when all the low-hanging fruit could be so easily picked, no longer works at the top of the S-Curve. Having reached the saturation-decline phase of the S-Curve, these policies have led to an extreme concentration of household wealth in real estate. Those who favored investing in China’s stock market have suffered major losses.

( 2 ) Demographics

Where China’s workforce was growing during the boost phase, now the demographic picture has darkened: China’s workforce is shrinking, the population of elderly retirees is soaring, and so the cost burdens of supporting a burgeoning cohort of retirees will have to be funded by a shrinking workforce who will have less to spend / invest as a result.

This is a global phenomenon, and there are no quick and easy solutions. Skilled labor will become increasingly scarce and able to demand higher wages regardless of any other factors, and that will be a long-term source of inflation. Governments will have to borrow more–and probably raise taxes as well–to fund soaring pension and healthcare costs for retirees. This will bleed off other social spending and investment.

( 3 ) The era of zero-interest rates and unlimited government borrowing has ended. As Japan has shown, even at ludicrously low rates of 1%, interest payments on skyrocketing government debt eventually consume virtually all tax revenues. Higher rates will accelerate this dynamic, pushing government finances to the wall as interest on sovereign debt crowds out all other spending. As taxes rise, households are left with less disposable income to spend on consumption, leading to stagnation.

( 4 ) At the start of the cycle, global debt levels (government and private-sector) were low. Now they are high. The boost phase of debt expansion and debt-funded spending is over, and we’re in the stagnation-decline phase where adding debt generates diminishing returns.

( 5 ) The era of low inflation has also ended for multiple reasons. Exporting nations’ wages have risen sharply, pushing their costs higher, and as noted, skilled labor in developed economies can demand higher wages as this labor cannot be automated or offshored. Offshoring is reversing to onshoring, raising production costs and diverting investment from asset bubbles to the real world.

Higher costs of resource extraction, transport and refining will push inflation higher. So will rampant money-printing to “boost consumption.”

( 6 ) The tech productivity boom was also a one-off. Economists were puzzled in the early 1990s by the stagnation of productivity despite the tremendous investments made in personal and corporate computers, a boom launched in the mid-1980s with Apple’s Macintosh and desktop publishing, and Microsoft’s Mac-clone Windows operating system.

By the mid-1990s, productivity was finally rising and the emergence of the Internet as “the vital 4%” triggered the adoption of the 20% which then led to 80% getting online combined with distributed computing to generate a true revolution in sharing, connectivity and economic potential.

The buzz around AI holds that an equivalent boom is now starting that will generate a glorious “Roaring 20s” of trillions booked in new profits and skyrocketing productivity as white-collar work and jobs are automated into oblivion.

There are two problems with this story:

1) The projections are based more on wishful thinking than real-world dynamics.

2) If the projections come true and tens of millions of white-collar jobs disappear forever, there is no replacement sector to employ the tens of millions of unemployed workers.

In the previous cycles of industrialization and post-industrialization, agricultural workers shifted to factory work, and then factory workers shifted to services and office work. There is no equivalent place to shift tens of millions of unemployed office workers,as AI is a dragon that eats its own tail: AI can perform many programming tasks so it won’t need millions of human coders.

… As for profits, as I explained in There’s Just One Problem: AI Isn’t Intelligent, and That’s a Systemic Risk, everyone will have the same AI tools and so whatever those tools generate will be overproduced and therefore of little value: there is no pricing power when the world is awash in AI-generated content, bots, etc., other than the pricing power offered by monopoly, addiction and fraud–all extreme negatives for humanity and the global economy.

Either way it goes–AI is a money-pit of grandiose expectations that will generate marginal returns, or it wipes out much of the middle class while generating little profit–AI will not be the miraculous source of millions of new high-paying jobs and astounding profits.

(End of Smith excerpt; emphases mainly his)

~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Have a nice day…

Funds Paying “Return of Capital” Give You (Sort of) Tax-Free Income

Scott Buchanan2 Comments

The stock of an individual company like AT&T, or a stock fund, often pays a dividend or distribution. Typically, these dividends are taxed as income. If you buy shares of a fund like MUNI that hold municipal bonds from U.S. states and cities, the dividends from that are not taxed by the feds (they are taxed on state income taxes). That’s nice, but the yield from a muni fund MUNI is only 3.3%, and the share price of MUNI drifts around with bond prices; it does not grow like the S&P500 stocks do.

What if there was a way to get highish dividends that are not taxed, at least not in the short term? There is. Funds classify their distributions or dividends in various categories. Net investment income or short-term capital gains are taxed like interest or ordinary income (highest rates). Qualified dividends or long-term capital gain returns are taxed at a lower rate. But “Return of Capital” (ROC) distributions are not taxed at all, when you receive them. (The accounting fiction is that ROC is simply your own investment money being handed back to you, rather than you getting interest or profit, which is why it is not taxed).

ROC only catches up with you when you sell your shares. Every dollar you pocket in ROC goes to lower the formal cost basis of your shares, so that increases the capital gains tax you pay when you sell.  Still, it can mean you defer paying taxes for many years, and when you do sell after many years, you will pay mainly long-term capital gains. Long-term capital gains have relatively low tax rates, and sometimes can be offset with capital losses elsewhere. So, this is a pretty good deal overall. All this only benefits you if you are holding these stocks in a taxable account, not in an IRA.

And, there are ways to not sell your shares, and hence never pay an inflated capital gains tax from all that ROC. One way not to sell your shares is to die (!). Your heirs inherit the funds at the current market value i (stepped-up basis”), without having to pay capital gains. So older folks do deliberately lard up their portfolios with ROC-paying funds or stocks, to leave to their heirs.

Another tactic is to donate the shares to charity. As I understand it, the donation gets valued at current market price, regardless of your cost basis. So, for instance, you might buy shares of XYZ fund at $100/share, collect say $50 in untaxed ROC over the next five years, and then donate the shares for a tax deduction at say $100/share (if their market price had not changed in five years). Obviously, this is only attractive if you wanted to make a charitable donation anyway.

OK, what are some funds or stocks that pay out ROC? There are number of funds which hold stocks, and write (sell) call options on them to generate income. (See here on selling options). Some (not all) of these funds pay out as mainly ROC, and are discussed here. SPYI and ETV are plain vanilla funds holding a basket of S&P500 type stocks, usually with a skew towards tech, and selling call options on them. (Or usually, selling options on an index like SPX or QQQ).  SPYI is currently paying about 11.5% yield, and ETV about 9%, both mainly ROC. ETV happens to be a closed-end fund, which can be good or bad, depending on whether you buy in when the share price is at a discount or premium to the asset value. Right now, ETV is at about a 5% discount, so it is a relatively good time to buy.

It is essential to note with these high yielding funds, the raw yield is practically meaningless. You have to look at total return, which factors in stock price over time as well as cash payout. The reason is that some funds “cheat” by paying huge yields, which sucks in investors, but those yields are not really earned by the fund, so those big payouts gradually deplete the fund’s assets.

FEPI holds an equally-weighted basket of fifteen tech stocks, and sell options on them. By selling options on individual stocks, the options income is huge; FEPI pays about 20% yield. The share price bounces around heavily, being so narrowly concentrated. If tech has a bad/good day, FEPI goes way down/up. QDTE also pays about 20%. It has a more novel strategy, selling “zero-day” options, which I won’t try to explain here. It has only been running about 6 months, but is doing OK.

A problem with all these option-selling funds is that their asset value goes down 10% if the underlying stocks go down 10%, but if stocks recover fast, the value of the funds typically do not recover as much. So, the share price of these funds keeps slipping below the price of a plain stock fund like SPY or QQQ. Now, if stocks go up (which they do most years), the price of an options fund can also go up, just not as much. The lag of these options fund is significant enough that on a total return basis (i.e. with dividends and stock price included), they usually lag behind just holding the stocks. Thus, the only reason to hold these funds is to harvest the tax-free ROC, or if you have a reason to want to generate steady income without selling off stocks.

Some 1-year total returns:

SPY        26.7%   Plain S&P 500  stock fund

SPYI       8.5%      Option fund

ETV        8.8%      Option fund

FEPI       20.2%   Option fund

QDPL     25.9%   Quadruple stock divi fund          

(Note, it is a little random that FEPI looked so good and SPYI and ETV looked poor in the past 12 months; that is not always the case. In the past 6 months, FEPI fared much worse than SPYI and ETV, which only lagged SPY by 1-2%). Some other newish option funds that pay mainly ROC are ISPY (8% yield, sells daily options, very little return lag) and three more with fairly low return drag: XDTE and QDTE (~20% yields, daily options on S&P500 and on NASDAQ 100); QYLG (6% yield; monthly options on half of NASDAQ 100).

Another fund I became aware of recently that pays mainly ROC is QDPL. It does not sell options, so it does not suffer the return lag the other funds do. It uses a futures strategy to take about 15% of the fund assets to garner roughly 4X the normal stock dividends of the S&P500 stocks. It only yields about 5.5%, but its total return keeps up pretty well with SPY. I like this one, and am including it in my portfolio with some of the options funds discussed above.

A whole other class of stocks that pay out mainly ROC is limited partnerships. These are common, e.g., among oil and gas pipeline companies like ET and EPD. These pay 7-8% and also are having strong share price appreciation. But they issue K-1 tax forms, which most mortals don’t want to deal with (I don’t).

As usual, this discussion does not constitute advice to buy or sell any security.