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“Wow!” is what I have to say about 2016.
There were so many important stories, but none were bigger than the rise of populism as expressed in the UK Brexit vote and the US presidential election. What has not changed is that business news remains overshadowed by geopolitics, the actions of central banks, international politics, local politics, demographic shifts, and so on. I remember a time when the news had scant mention of these factors. Instead, quarterly earnings releases (“earnings season”) and the intervening periods were the big moments for business news. Not so much any longer.
Another big story, though it’s still early in its development, is the decoupling of equity and fixed-income markets from one another. After the Great Recession, an odd thing happened: Equity and fixed-income markets started to move in tandem and began trading in similar directions and at similar magnitudes. It was conventional wisdom that the two were negatively correlated. Well, that negative correlation appears to have returned.
Call me old fashioned, but businesses, security selection, and active management still matter. So, were I still making such decisions for the good of a shareholder, the following are the best stories I read in 2016:
The story of the year is that productivity in the US turned negative for the first time in 30 years. Without productivity there can’t be actual economic growth. It is tough to make a compelling argument for secondary market investing without economic growth. No matter who is president, whether there is a hard landing from Brexit, or negative interest rates continue, productivity over the years is why we are viewing these events on electronic screens.
This year Eaton Vance launched a revolutionary new investment product called NextShares that changes portfolio structure. Think of a hybrid between a traditional mutual fund and an exchange-traded fund (ETF).
Early in 2016, BlackRock CEO, Larry Fink, suggested it was time for research analysts to begin looking past quarterly earnings. Kudos to the asset management behemoth. Is this shift ever going to happen? I can’t help but think that moving the focus of both businesses and their capital stakeholders toward longer time horizons will lead to a better outcome for both.
Research released earlier this year from GMO demonstrates that 25% of stock market gains going back to the 1980s have occurred on US Federal Reserve announcement days. Please, can central bankers let the markets be?
And this piece, my third most important story of 2016, notes that stock buybacks dwarf all other activity in US stock markets. Again, can we please let the markets be? You can’t tell me that in a rising equity market environment, marginal stock buybacks are made at economic prices.
Tangential to the preceding paragraphs, this open letter from the Organization for Economic Cooperation and Development (OECD) declares that we need to “Stop Pretending That an Economy Can Be Controlled” and qualifies as my fourth most important story of the year.
The following missive by one of the United Kingdom’s financial geniuses, John Kay, is in a similar vein. It highlights that Warren Buffett is widely worshiped, but that few actually attempt to copy his formula for success. I could not agree more.
One thing active managers can do to improve returns is to actually do the research. Believe it or not, in this era of big data and artificial intelligence (AI), a human being’s unparalleled ability to contextualize and to think creatively still results in insight and not just data. Check out this story about how one of Lending Club’s biggest proponents uncovered some questionable loans by using his brain.
Many are describing the current media era as post truth. This article supports that contention. It describes how a misquotation can spread rapidly, and in some cases become the truth. I like the original headline: “An Apt Misquotation Can Reveal the Greater Truth.” As successful investors, we first must see the world for what it is and not for what we desire it to be. Stories that illustrate just how difficult this can be in our current media era are critically important.
Scientists have declared: “We Are All Confident Idiots.” What gives them such confidence in this assertion? They conducted surveys asking people to recall factual information. They also asked people their level of confidence in their answers. When these groups were divided into quintiles based on the accuracy of their answers, they found that the confidence of the most and least accurate respondents was identical. That is, the more ignorant we are, the more confident we are in our answers. The researchers observed that this finding applies to all groups of people, regardless of intelligence level. In other words, overconfidence is real. Similarly but separately, researchers also found that subject matter experts are twice as likely to have false memories about facts and data.
A critical read is this article on “The Enormous Power of the Unconscious Brain.” One fundamental quibble I have with it is the equation brain equals mind. My understanding of quantum physics leads me to believe that consciousness is non-local. This makes the brain a kind of radio set, or tuner, for the mind.
My second most important selection of 2016 is an exceptional piece by a lifelong researcher into the workings of the brain that points out the obvious: The brain is not a computer and does not process information like a computer. Unfortunately, the brain-as-computer mental model is used so frequently that it may be difficult to imagine the mind as anything else. As the author makes clear, the overemphasis of this perception is actually detrimental to the understanding and advancement of the science of the mind.
Environmental, Social, and Governance (ESG)
Renewables are the largest source of new energy capacity coming online in the United States. You may think this is not a big story, but oil prices have been very low. It used to be that a case for renewables could be made only if the price of oil was high. It turns out, the price per unit of renewable energy is becoming more and more competitive. Combine that with another important story — oil discoveries are at a 70-year low — and you have the makings of an approaching inflection point.
Back in the late 1990s and early 2000s, many in the energy sector thought California was foolhardy for investing so much capital in alternative energy. Now the state is having a laugh at the expense of its critics. Here is what other states and nations could learn about solar energy by following California’s example.
A study claims executives purposefully manipulate earnings and investors for their own benefit. It’s a depressing reminder of why so much of the public does not trust businesses and investors.
The p-value, a classic measure in statistics, has been under assault for the last several years. I believe its holes need to be understood by every responsible investor.
I want to highlight the quality of this deconstruction of an investment book by someone well versed in derivatives. What I liked about this extended deep dive was not the criticism, but the overview and unique perspective of this derivatives investor. In short, I learned a lot
ProPublica broke a story that computer programs designed to evaluate the recidivism rates of criminals massively overestimate the rate for black defendants and massively underestimate that for white defendants. So how does this relate to investing? Algorithms need to be evaluated, and algorithm authors need the means and mechanisms to gain transparency into their own biases. Otherwise algorithms produce what you want them to produce. Put another way: Garbage in, garbage out!
Too bad that earnings per share serves as a proxy for business performance, otherwise investors, traders, and others might start to focus on critical competitiveness issues. Thankfully, there are steps to take to distinguish between real business performance and fakery.
Fun Stuff Stories of the Year
Many of my favorite stories this year dealt with consciousness. What is it? How do we cultivate more of it? Why is it important? Here are two theories described in two articles that jointly hold the fifth spot in importance for me this year:
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: CFA Institute
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