Bob’s Journal for 1/16

Stock prices aren’t the only feature of the stock market which are reaching record highs.

The percentage of the companies listed on the stock market exchanges that have reported losses is rising. A report from Société Générale featured in The Wall Street Journal concluded that almost 40% of the listed stocks reported losses over the last 12 months. That’s the highest percentage since the late 1990s.

In 2018, the percentage of companies reporting losses over three years was also the highest it has been since the late 1990s. One group of money-losers are those that recently had initial public offerings (IPOs).

It used to be that a company couldn’t issue shares to the public until it showed that it could make a profit. That’s not the case now. About three-quarters of last year’s initial public offerings (IPOs) were unprofitable.

About 42% of the money-losing listed companies are in health care and another 17% are in technology. Those are the sectors in which investors believe that a small, money-losing company with a good idea is likely to become very profitable in a few years.

Another type of money-losing company is exemplified by GE. This former giant of the U.S. economy has been struggling to compete in the changing economy and has lost money for several years. However, investors are feeling better about GE because its stock price increased about 44% in 2019.

About 40% of the companies with losses had their stock prices increase. Of the 100 biggest companies that reported losses over the last 12 months, about 75% saw their stock prices increase.

Smaller companies dominate the list of money-losers. These are often companies that are losing their market share to larger companies, especially the newer, disruptive companies. Close to 40% of the smallest 80% of companies have reported losses for three years.

The real issue for most investors is how long investors as a group will continue to buy shares in companies that are losing money. It is possible that, as in the technology stock boom of the late 1990s, investors will, at some point, decide that there’s too much risk and then take their money elsewhere.

Are ETFs Diversified?

Many investors who want to invest in a particular market sector opt to do so through an exchange-traded fund (ETF).

They should know that many sector ETFs aren’t very diversified and the level of diversification varies by sector, according to a report from the Bespoke Investment Group.

In the S&P Energy sector, for example, two stocks (Exxon (XOM) and Chevron (CVX)) account for about 43% of the sector. In Communications Services, Alphabet (GOOGL) and Facebook (FB) are just under 42% of the sector. In Technology, two stocks account for just under 40% of the sector, Apple (AAPL) and Microsoft (MSFT).

The sector in which two stocks account for the lowest share of the ETF at 12.4% is Industrials.

The indexes are capitalization-weighted, meaning that the stocks which have the largest market value have the greatest weight in the index. The S&P 500 has become more and more concentrated in the 10 highest-capitalization stocks over the last few years. It makes sense that these sectors also are have a heavy level of concentration in a few stocks.

There’s nothing wrong with a sector fund being concentrated in a few stocks as long as the investor knows that when buying the investment. But you also should ask why it makes sense to pay the ETF’s management fee and other expenses when you can now buy the top two or three stocks at many brokers without paying a commission.

Another Argument Against Artificial Intelligence

Last fall, I pointed out that artificial intelligence (AI) doesn’t work well for investors.

Following a lead from Tom Sosnoff of TastyTrade, I pointed out that an ETF which invests using artificial intelligence (AI Powered Equity: AIEQ) trailed the S&P 500 by a wide margin.

Here’s more evidence against using AI to guide stock market investing.

A few years ago, an academic concluded that using AI to invest would beat the stock market by as much as 40% on an annualized basis. He used historical data to develop hypothetical investment results.

More recently, however, the same academic and a couple of colleagues refined the approach and reached different conclusions.

They found that a large percentage of the returns from using AI were generated from stocks with small market capitalizations and trading volumes. That means the strategies couldn’t be profitable on any scale as the trades would move market prices too much. About half of the hypothetical profits disappeared when trades were restricted to readily tradeable stocks.

The investments that were selected after the AI strategy was refined were very similar to those generated by using widely used factor investing. These are portfolios that focus on stocks with the qualities that studies have found to be more profitable than the market indexes. These qualities include low volatility, low price-earnings ratios, small companies and others. But factor investing also hasn’t produced real world results that match the hypothetical returns.

While AI might do well in other fields, it has a way to go before it replaces the investment methods that are already in use.

The Data

The Small Business Optimism Index from the National Federation of Independent Business (NFIB) declined a bit in December to 102.7 from 104.7. Expectations were for a smaller decline. Seven of the index’s 10 components dipped. But a higher percentage of businesses expected better business conditions over the next three months. The number of firms that are planning to raise their compensations are at one of the highest levels in the survey’s 46-year history.

The Consumer Price Index for December increased 0.2% compared to a 0.3% rise in November. Excluding food and energy, the index increased 0.1% in December, down from 0.1% in November. Over 12 months, the two measures each increased 2.3%.

The Producer Price Index gained 0.1% for December compared to no change in November. Excluding food and energy, the index increased 0.1%. Over 12 months, the two measures increased 1.3% and 1.1%, respectively.

There was finally a bright spot in manufacturing as the Empire State Manufacturing Survey for January increased to 4.8 from 3.5. New orders, shipments and employment all improved. But survey respondents were less optimistic about the next six months.

Last Friday’s Employment Situation reports provided ammunition for both bulls and bears.

The headline number was that 145,000 new jobs were created in December. That’s a healthy number by historic levels, and it definitely is a strong number for an economy that already has a very low unemployment rate. But expectations were for about 160,000 new jobs, and the recent trend has been about 190,000 new jobs. So, bears can argue the labor market is getting weaker.

The strongest evidence for bears is the 1% annualized monthly increase in average wages. Wage growth was weak for most of the post-financial crisis recovery, but the last couple of years have seen wage growth bouncing around the 3% annualized rate. December had the weakest monthly growth since late 2017 and was among the lowest rate of the past five years.

The Markets

The S&P 500 rose 1.46% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.22%. The Russell 2000 increased 1.07%. The All-Country World Index (excluding U.S. stocks) added 1.18%. Emerging market equities jumped 2.79%.

Long-term treasuries rose 0.79% for the week. Investment-grade bonds increased 0.50%. Treasury Inflation-Protected Securities (TIPS) added 0.32%. High-yield bonds gained 0.37%.

In the currency arena, the U.S. dollar increased 0.42%.

Energy-based commodities fell 3.10%. Broader-based commodities lost 1.56%. Gold declined 1.60%.

Bob’s News & Updates

Join me for the Orlando MoneyShow, Feb. 6-8, 2020, at the Omni Orlando Resort at ChampionsGate. I will be speaking Thursday, Feb. 6, 11:30 a.m. about Important Changes in IRAs and Other Retirement Planning Strategies You Must Know. On Feb. 7, I will talk at 11:30 a.m. about 10 Questions You Must Answer Before and During Retirement. Other investment experts who will be speaking include Hilary Kramer, Bryan Perry and Mark Skousen. Register by clicking here or call 1-800-970-4355 and mention my priority code of 049320.

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I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.

P.S. I encourage you to check out my latest special report titled, Bob Carlson’s Guide to Inheriting IRAs. The report has been prepared free for you as one of my valued subscribers.