BATS Exchange gains primary listings

Today the BATS Exchange, based in Kansas City (i think this is in Kansas?) listed 7 ETFs. I am probably the only person I know who got excited about that (please leave a comment if you too were excited!!).

There are two primary costs to investors buying stock: Commission and the Bid-Ask spread. Commission is obvious, your broker will tell you exactly how much that is when you make a trade, often a fixed rate below $10 for online trades. The Bid-Ask spread is a little trickier. Basically, the Bid is the price a dealer will buy a stock from you and the Ask is the price they will sell to you at. For heavily traded stocks, this is generally a tiny spread, a few pennies of less. For more lightly traded stocks, and importantly, many newer ETFs, this spread can be much wider. A wide spread means the investor gets a worse price weather buying or selling.

The primary beneficiaries of this will be large traders and dealers with access to the exchange. Lower listing and trading costs increase the appeal of the exchange to market makers and other dealers. BATS also tries to offer faster trade matching and filling. Attracting more participants to an exchange should lower prices on that exchange.

Benefits are not limited to the big players though. Innovation and competition in financial markets has been bringing down costs for individual retail investors and traders since the first exchanges opened. NASDAQ’s all electronic trading lowered costs for dealers, who could pass on some savings to customers to gain business. Tighter Bid-Ask spreads and decimal trade denomination made trading more efficient for mutual funds and now ETFs used by retail investors, reducing some of the ‘hidden costs’ to fund investing. Adding primary listings to a third exchange in the US will ultimately be good for the retail investor.

I think we should all be excited about this.

the problem with analogies

Wherein i get a bit tired of an old story popping up again and decide to make my own faulty analogy in response. I’ve seen this before in various ways, but here it is, pretty much in full:

An economics professor at a local college made a statement that he had never failed a single student before, but had recently failed an entire class. That class had insisted that Obama’s socialism worked and that no one would be poor and no one would be rich, a great equalizer.
The professor then said, “OK, we will have an experiment in this class on Obama’s plan”. All grades will be averaged and…… everyone will receive the same grade so no one will fail and no one will receive an A…. (substituting grades for dollars – something closer to home and more readily understood by all).
After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little..
The second test average was a D! No one was happy. When the 3rd test rolled around, the average was an F. As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else. To their great surprise, ALL FAILED and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed. It could not be any simpler than that.

It would be great if that last line were true. If everything in life could be simple. Alas.

I’ll start off with a bit of rounding out here. Firstly, Obama is not a socialist. I could go on and on and on here, but that is it. Obama is not a socialist. Full stop. Additionally, I am pretty sure he does not have any “plan” to force everyone to have the same income (as is the implication). Of course at this point, you can dismiss me as a lunatic for not getting the humor in the hyperbole here. Just tell me to loosen up or something.

It is interesting to note, at this point, that the economics professor had never failed anybody. So working in the analogy of grades as income and this class as a nation: that professor was the dictator of a country which had never experienced poverty. It would be nice if that is how things were in the real world, but no, the US has a poverty rate (failure rate? failure at life?) of 15.1%. Also the average grade of B on the first exam is an interesting phenomena that economists can explain: inflation.

Something just doesn’t sit quite right with the analogy though. It is a test, not an open market that people are trying to succeed at. It is as if there is only one possible job in the economy, people cannot use their cunning and skill as they see fit, they can only attempt to satisfy some incredibly top down checklist and reach out for their paycheck. This is more appropriate for a manager of an assembly line where everyone gets paid the same for the same job because, you know, that makes sense, but not quite. The classroom is not an economy – the students are only having an interaction with the professor – they are not interconnected (ok, they can, but not in the given example). In the real world, a businessman’s success depends on his customers having the money to support his store. These different roles are not represented in this analogy.

So I started thinking, how could we make this analogy work?

I will spare you the details of my thought process because it involves me taking a shower and thats just not something that I need to get into right now, but here is what I came up with.

This class is a freshman maths class or something else big and freshman and lecture based. Everyone in the class has different skills, different test scores, different resources and different material goods. Some of the kids are super smart and have great test scores, others just have decent scores but learn quickly and know a lot of resources to use to get more information, some kids just have all of the right books, they paid for the extra texts suggested for the class, but maybe have not read them, some kids are smart, have great scores, all the books and know every possible resource out there, others have poor scores and no books or knowledge of reasources. This is an intro lecture course, so there are enough people to make a pretty broad range of combinations, but the idea is that nobody is the same (duh).

The professor says that the goal is to learn (duh, again). Lets go ahead and make the grade = money analogy link (sure). Well what is learning? That is your success or whatever you want to call it. So learning leads to grade grades, much like success leads to money.

Now the professor splits everyone up into groups and sets them on a project where they have to learn something and make a presentation and take a test (ugh, that sounds like school. Typical professors, making people learn and stuff). The success of the group is dependent on the success of the individual members (to stick close to the original analogy, the group grade is just the average of everyones part of the presentation), though of course, everyone will be getting their own grade on the test (how un-creative this professor is).

Within each group, some people are keen to learn and have access to lots of resources (like, wikipedia or something). Some understand the assignment pretty well from the get-go, others have no clue what is going on. Some are natural leaders, while others are hard working, lazy or possibly both (manic?). I am going to wind down talking about my analogy here because it should be pretty clear what is happening. Everyone in the group realizes that their grade depends on everyone LEARNING. Their grade, their income, depends on everyone doing well, everyone learning. This actually becomes a better case study on education really quickly (because group projects and teaching someone else something are really great ways to learn for everyone involved). The kid with the books benefits if he shares with others, the kid who gets what is going on benefits if he explains it to others. The born leader may get them all organized while the hard worker gets to work pulling information for the others. When it comes time for the presentation, the individual parts are graded and then averaged (this is like taxation, i take it).

While the people who learn the most and do well on the test earn a better grade overall, as well they should, they cannot deny that their classmates had a great impact on their actual success. While the skills and motivation and resources that they had before they came to class helped drive their success, everyone benefitted from the sacrifice of time and effort to help each other. Also, doing a large, multifaceted presentation on your own is hard, by the way.

I am rapidly falling apart trying to explain this, but you can see what I am saying here.

In case you missed it, taxes are what we pay (not 100%, mind you, nobody is starving after taxes who wasn’t starving before them) so that someone else (conveniently, the government, this is the whole point of having one, btw) can go provide those resources and education and healthcare and know-how and what not to those who need them, because it would actually be quite difficult if everyone had to do that individually.

You can extend this analogy to talk about the smart kid who never did well on tests, or the kid who just bought and memorized the cliff notes and made great grades but was actually a total idiot, and the kid who just happened to be in the right group, with the really nice kid who did a lot of the work for them… but you get the point.

In an economy, everything is interconnected. A businessman with a great idea for a product will fail if nobody has any money to buy it. A great middle class forms the body which consumes the goods made. If iPhones were priced such that only the top 1% of the population could buy them, Apple would be far less successful than it has been. (OK, fact check on myself: only 73.5 million iPhones have been sold so it is entirely possible that they all went to the top 1%, so fine, rich people make good customers. But think of Nokia, or Johnson and Johnson, or MMM!) It is the middle class consumers what create jobs when they purchase goods and services.

Social safety net programs are not some sort of charity, and they are not to keep people from working, they are to prevent people from falling into dire poverty. Our economy depends on people being well enough to work, and well off enough to consume products. If people slip into dire poverty, they aren’t well enough to work, nor well off enough to consume. Everybody suffers as a result. This is not some frozen tundra, where the weak can simply die off as the strong fight in a brutal evolutionary environment, this is civil society. Sure, evolution still happens, and hard work should lead to success, but no infrastructure and a bunch of incompetent workers and dead consumers is not the ticket to GDP growth.

(If you want a real free market example, take the dictatorial professor out. Just chuck everybody into a room with a test and see what happens.)

(Also, while we are on analogies, baseball. While of course the successful teams will generally make more money, pay better for better talent, etc, the league shares tv revenue etc. This isn’t charity, nobody would watch baseball if it was just a couple of filthy rich teams shutting out every game they showed up to. Ok, bedtime.)

lending to foreigners.

A recent article at SmartMoney.com promotes the idea of buying foreign bonds. The article notes that many foreign countries are in great financial shape, some have more assets than liabilities, leaving no question about their solvency. Many issues pay higher coupon rates than US Treasuries, notably Norwegian bonds, which yield 2.5% on a 10 year, compared to the US 2% yield.

Buying individual bonds is difficult for an individual investor. Information about the bonds generally only arrives twice a year – when you receive your coupon payment. The market is opaque and dealer driven. While some brokers have online bond search tools, these are generally ill suited to the nature of the market, where a dedicated fixed income desk can add a lot of value. Also, in a pinch, it may be hard to get a good price when selling a bond.

Also, unless you have the money to dedicate to a sufficiently diverse array of bonds (generally about 10 issuers, at 25 bonds of $1000 a piece = $250,000) you risk losing a significant chunk of your money to a single default. If you don’t think default risk is that big of a deal, just think, the Euro has been around about 10 years and already the bonds of Ireland, Portugal, Spain and Italy have suffering varying degrees of distress, not to mention Greece, which looks likely to suffer a default of sorts soon. This sort of volatility wouldn’t sit well with the average fixed income investor.

Foreign bonds do offer advantages to US bonds, of course, but there is more than just yield. Besides the general pros and cons of treasuries or corporate bonds, foreign denominated bonds offer the chance to participate in any change in the currency’s value. An American investor would benefit from this currency bet if the dollar depreciated, and lose out if the bond’s currency depreciated. This may not be a bet that the average fixed income investor wants to enter into.

This is what it looks like when you want to buy foreign bonds. Does this make sense yet?

For American investors, building a ladder of carefully selected individual bonds can be a great way to spend $250,000 and have fairly reliable cash flows effectively in perpetuity (rolling over matured bonds into the longest maturity desired). This is key for the investor who needs to generate stable income from their portfolio. However, not everyone needs bonds for income, or has that much to invest. In that case, funds may be the way to go.

There are two main uses for bonds in an investment portfolio: to generate cash flow and to act as a diversifier. As far as cash flow, individual bonds are a great idea. Without paying fund fees, working with a broker, one can build a portfolio which only needs tending to once a year and squeezes a few extra basis points of yield over the broader market. Again, this is an expensive option, so the smaller investor may want to turn to funds, where a professional (or a computer) takes care of all the selection process for you and pays out interest to you from time to time.

The main benefits of foreign bonds over domestic bonds is diversification. While in general, bonds will act like bonds, foreign bonds offer currency and inflation characteristics unlike domestic bonds. In this way, they can form a unique asset class in your portfolio. Big bond names like BlackRock and PIMCO offer mutual funds covering developed and emerging market bonds. Templeton also offers a Global Bond Fund and a Total Return cousin which spreads its bets worldwide for a reasonable cost to the investor. With the growth of ETFs in this area, it is even easier to add foreign or emerging market bonds into your investment mix with WisdomTree’s Emerging Market Local Debt Fund or PowerShares Emerging Markets Soverign Debt Fund.

The author at SmartMoney has a great point: foreign denominated bonds do offer some benefits over US Treasuries, but it is important to consider the risks too, before jumping at the extra basis points of yield. Importantly, with fixed income, the way one chooses to invest can have a huge impact on performance. If you are interested, talk to a Registered Investment Advisor about the appropriateness of holding foreign bonds.

the wrong way of looking at it.

Saving money for retirement is generally accepted to be a good idea. Getting someone else to save some money for your retirement is also a pretty good idea. So when someone comes out saying that all this saving and matching saving is not such a good idea, you have to stop and see what they are saying.

Steve Gandel, writing in Time, asserted just that.

Many companies offering deferred compensation retirement plans (like 401(k)s or SIMPLE IRAs) will match some (usually the first 3%) of the employee’s contribution. This means that if you pitch in 3% of your income to your 401(k), your employer will also put in the same amount. Advisors like myself like to call this “free money” because it pretty much is.

Stephen writes:

Well, it turns out that money isn’t exactly “free.” In a sense, it’s actually coming right out of your paycheck.

What is less understood is that even the money that employers contribute to those accounts is really coming from workers as well.

All else being equal, they found that workers at companies that contributed to their employees’ 401(k) accounts tended to have lower salaries than those at companies that gave no retirement contribution. In fact, for many employees the salary dip was roughly equal to the size of their employer’s potential contribution.

To say the ‘employer match’ is coming out of the worker’s paycheck is missing the point. That implies that if the employee did not participate, they would get that 3% anyway. No, they won’t. The only way to get that 3% is to participate, and contribute.

Of course the money has to come from somewhere! Nobody should be too surprised that a company takes benefits into account when coming up with a dollar salary for a given employee. A key benefit to the 401(k) is the forced savings.

The author notes the good news though, lower earning employees salaries are less affected by the presence of an employer match, pretty much confirming exactly what everyone means by “free money”, even without the chance you may be giving up a bit of salary for that benefit.

What’s more, the conclusion that Toder and Smith draw from their data is that for low-wage workers 401(k) plans might actually be a bit better than is thought… A low-wage female worker salary drops only by $0.11 for every dollar of company match. The salary of a low-income male worker drops by $0.29. Combined 401(k) contributions and compensation of a low-wage worker at a firm that provides a 401(k) match is higher than that of a peer at a firm that doesn’t offer 401(k) contributions.

He then turns back around to defend his original silliness saying:

The problem with Toder and Smith’s analysis is that not everyone participates in their company’s 401(k) plan. And low-wage workers tend to have much lower participation rates than high-earners.

This is just a good argument for increasing participation, though. Combine this with the aforementioned benefit and BAM! you get exactly what financial advisors have been saying for years. Basically the article has completely canceled itself out at this point.

He ends by trying to revive his absurd disgust with retirement savings by blathering on and contradicting his earlier (contradictory?) statements.

Many low-wage workers can’t afford to defer a portion of their salary for later. Also, Social Security… may be all they need. So not participating in a 401(k) might be a rational choice.

Firstly, yes, not being able to save money is a sad fact of low wage employees. That is one thing that financial planners do, try to help people save more money. An article in TIME is not going to upend the value of saving money. Secondly, as a financial advisor who has seen many people’s social security statements and looked at their financial needs – it is generally not enough. Period. It is nice, and many people can make it work quite well, but social security is not going to keep most people comfortable in retirement. Some people may be able to eke it out on social security in retirement, but it is ignorant to suggest that people should not try another option. I guess from his desk at TIME he may not have the opportunity to learn that most people still need to be encouraged to save.

For a giggle, here are two actual sentences from the article.

…the conclusion that Toder and Smith draw from their data is that for low-wage workers 401(k) plans might actually be a bit better than is thought.

The bottom line is that 401(k)s for many poor workers are not a better deal than we had thought.

Ok. Researcher v TIME Journo. It’s on.

For a bit more context, the author is looking at 401(k)s as a raw deal compared with guaranteed income pensions. Fewer and fewer companies offer pensions; it is a good thing that some offer any type of retirement savings mechanism! If he is downing 401(k)s for taking money from employee salaries, where does he think that pension funds came from? Yes, 401(k)s put the onus of saving onto the worker, saying they are terrible is an insult to any worker who recognizes it is their responsibility to prepare for their own future.

Independence and Objectivity

Or, the importance of doing your own research.

The volume of financial articles published every day is phenomenal. Not only are there press releases and analyst reports, but mainstream financial media like the Wall Street Journal and Bloomberg are followed by legions of independent and networked bloggers such as are found at Seeking Alpha and Motley Fool. This volume is daunting to the individual investor wanting to learn about a company. Analysts down to individual bloggers are keen to crank out their own analysis to gain larger audiences and influence.

How should one deal with this fire hose of information?

Ignore it.

There is some use to this information, there are tidbits of actual, objective fact floating in the ocean of words. A brief scan of an article can draw that out. However, there are a lot of mistakes, particularly in the rise of blogs that appear to be written from a formula or template, with no actual thought or analysis in the process.

Motley Fool uses templates to answer standard questions. Their “Why did my stock just die?” template takes stocks with huge one day drops and attaches an important news piece to each, inserting a bit of opinion, but generally leaving the analysis up to the reader.

There is nothing very wrong with using a template or a form to produce or present analysis, it brings discipline and consistency to the field. However, the terrible trend here is ridiculously incomplete analysis, or blatantly ignorant analysis.

The first ignorant article I encountered today was about railroad stocks. The headline tipped me off that the analysis would be the product of ignorance. “Four Railroad Stocks With Potential In 2012” This caught my eye because 1) I like railroads and 2) there are only 8 operators in North America, and only 15 railroad related companies traded in the US. To find 4 with potential is kind of like saying “Here are 1250 stocks that may be interesting.“

Reading the article, you can see that it is essentially a list of facts about the company, drawn from pretty much any financial website or earnings release, presented in paragraph form. There is no analysis here except a few sentences like “…will benefit from an improving economy.” and “I think Jim Cramer is right.” The former statement is practically self-evident so long as you are not talking about shorting the market and the latter is probably a joke, though the author does not realize it.

So, at this point, this article is simply an aggregation of facts from elsewhere, great, useless. However, reading what railroads the author decided to call competitors. Of course, all railroads compete with (and cooperate with) each other in some way, but this article avoids selecting any of the screamingly obvious, overlapping networks to call competitors. The article pairs Norfolk Southern’s east of the Mississippi network with BNSF’s network which starts on the west coast and meets NSC in the middle. Union Pacific, with their network solidly in the Western US only competes directly with Canadian National in the Chicago – St Louis – Memphis stretch. CSX, whose network overlaps with NSC is paired with Canadian Pacific, who has a network that overlaps pretty much completely with Canadian National.

(Just to be complete, here is my opinion of the most direct competitors based on operating region: NSC with CSX, UNP with BNSF, KSU with everyone in the middle, but uniquely nobody due to their reach deep into Mexico)

Basically, anyone reading that article would learn nothing that the company had not already said (probably in much more detail) within the past few months, and would have a perverted idea of who the railways were competing with. There you go, a waste of your time (and clearly mine too).

Another shockingly bad article had even worse implications.

A lot of investors depend on dividends not only as a sign of health of the company, but as a source of income. When an ignorant blogger proclaims they have found a huge, safe dividend, someone may take a wrong turn if they follow the blogger’s advice.

Forbes has lent this article its credibility by hosting it. The article proclaims that investors can pick up an 11% yield cheaper than insiders have bought recently.

This article is riddled with basic errors and misleading statements.

Firstly, not all insiders are buying. In fact, the most recent SEC filings indicate selling, at an even lower price than the buying touted in the article.

Next are maths errors. The article boldly proclaims that SVP Moore, who bought at 17.50 on 8 August, has lost 110.8% of his investment. This is fairly shocking, of course, because it means he now owes money just to hold the shares. This is simply untrue. I won’t even wade into the ridiculousness of that.

The last thing I will mention is the dividend. Or, the lack thereof. 26 October, weeks before this 17 November article came out, Orrstown Financial Services released their quarterly earnings and announced in the same statement that they were discontinuing their dividend. When this announcement came, there was a massive selloff in the stock. This is apparent from the chart shown in the article. Even the least inquisitive of investors would notice this and ask “why did that happen?” and with very little effort, realize that this was no longer a dividend paying stock.

There is a lot of financial news and analysis out there. Ignore it. The only thing you need to do to analyze a company is start asking questions, and then look for the answers. You won’t get that from 99% of blogs out there.

Disclosure: I own both NSC and ORRF.