Bob’s Journal for 5/26/21

It is not too late to make plans to join me at the MoneyShow in person in Orlando, Florida.

The Orlando MoneyShow will be at Championsgate Resort, June 10-12. In addition to me, speakers include Larry Kudlow, Mark Skousen, Hilary Kramer, Jon Najarian, Jeffrey Saut, Jeff Hirsch and Louis Navallier. Click here to register or call 1-800-970-4355 and mention priority code 052691 to attend for free.

Are New Regulations Coming for Index Funds?

Regulators are starting to realize that many index funds aren’t the simple, plain-vanilla investments many people believe they are, and the regulators are starting to take action.

I have long objected to two characterizations commonly made of index funds. One characterization is that an investment in an index fund is an investment in “the market.” All the major indexes are composed of a portion of the stocks traded in the public markets. The stocks either are selected by people or by formulas constructed by people.

While the major indexes strive to be representative of the total market or a segment of it, they aren’t the market. The different returns of the various indexes show that choices are made in the construction of the indexes.

Of course, even more choices are made when constructing indexes that represent market sectors or different styles of investing, such as value or growth stock investing, instead of the broad market.

A related characterization is that index investing is passive investing. The investor in an index fund might be passive. But construction of the index itself and attempts to mimic it by the fund managers aren’t passive. People are doing a lot of work and making a lot of choices.

The S&P 500 and its related indexes, for example, are set by a committee of employees at Standard & Poor’s. They meet on a regular basis and debate which stocks to add and subtract from the index and when to make the changes.

The committee also decides which sector is assigned a stock. The decision sometimes is controversial and can make a big difference in sector returns.

The process seems to me to be similar to what takes place at actively managed mutual funds. The main difference is changes are made less frequently in the S&P 500 and most indexes than at many actively managed mutual funds.

In perhaps the first step toward tighter regulation of index investing, the Securities and Exchange Commission (SEC) recently announced a settlement with S&P Dow Jones Indices (S&P) that included a $9 million fine.

The action was related to the fund’s construction of the S&P 500 VIX Short Term Futures Index ER. Credit Suisse licenses the index and uses it to construct an exchange-traded note series.

S&P didn’t disclose to Credit Suisse or to investors that the index has an “auto hold” feature that freezes the value of the index anytime changes in the prices of the securities tracked in the index surge beyond certain thresholds.

Such a surge happened on February 5, 2018, when the securities rose 115%. But S&P reported the index as unchanged.

Some researchers have argued that firms that construct indexes are performing the same functions as investment advisors, at least regarding the construction of sector or specialized indexes. The index providers say they are data compilers and publishers. At least one commissioner at the Securities and Exchange Commission (SEC) said the agency should consider expanding its regulation of index funds.

The immediate point for investors is to recognize that most indexes are constructed and managed by people making decisions. Before investing in one, you should know how the index is constructed and how it differs from other indexes.

Bitcoin’s Wild, Unprofitable Ride

One thing you can count on with the digital currency Bitcoin is volatility.

It is not unusual for Bitcoin’s price to move 10% in a short time and 30% or more during a day.

Bitcoin’s longer-term price patterns are even more interesting. A recent study by Bespoke Investment Group found that over the last 10 years the price of Bitcoin often is well below its recent record high.

On any given day during the 10 years, the price of Bitcoin was on average close to 50% below its previous record high. On 69% of trading days during the last 10 years, the price was more than 40% below the record high.

The data indicate that when you buy and sell Bitcoin is critical to determining whether you make money. The timing must be very good.

Another conclusion is that the total losses of investors in Bitcoin is extremely high. That’s because a large number of investors buy close to record highs, and Bitcoin frequently trades below its record highs.

Another Myth Destroyed

Most people make decisions, especially financial decisions, using rules of thumb and mental short cuts. That’s usually a bad idea.

Some recent research examined strategies for ordering wine at restaurants.

The conventional wisdom, or rule of thumb, is to avoid buying the second-cheapest wine on the list.

The thinking is that the second-cheapest wine will have the highest markup. The restaurant knows that most people don’t want to appear overly frugal and so will avoid buying the cheapest wine. They’ll gravitate to the next-cheapest wine. Knowing that, the restaurant will ensure the second-cheapest wine is the one with the highest profit margin.

But a study of London restaurants (did you know there’s an organization named the American Association of Wine Economists?) exposes this as another urban myth and shows why it is important to use real data instead of theories, mental shortcuts and rules of thumb.

The study found that the highest mark-ups were on the mid-priced wines. The mark-ups then decline for higher-priced wines. The second-cheapest wine had a significantly lower mark-up than the next four higher-priced wines.

The Data

New unemployment claims declined again and were lower than forecasts. New claims were 444,000 in the latest week, down from 478,000 the previous week.

New claims are at their lowest level since March 14, 2020.

Continuing claims increased by 111,000 to 3.75 million.

About 16 million people are receiving some kind of unemployment benefit, which is a decline of almost 900,000 from the previous week.

The Philadelphia Fed Manufacturing Index for May was 31.5. This is a decline from April’s 50.2 level but still an extremely strong level.

The prices paid segment of the index increased to its highest level since March 1980. Also, the prices received segment of the index increased to its highest level since May 1981. Almost 77% of firms reported paying higher prices for inputs and none reported paying lower prices.

The Richmond Fed Manufacturing Index increased to 18 in May from 17 in April.

The Leading Economic Indicators index, as compiled by The Conference Board, increased 1.6% in April following a 1.2% increase in March.

Economic growth continued to increase in the first half of May but was especially strong in the services sector, according to the PMI Composite Flash Index.

The Manufacturing Index from PMI increased to 61.5 from 60.6. The Services Index rose to 70.1 in early May, compared to 63.1 at the end of April.

Existing home sales declined by 2.7% in April from March’s level. That’s the third straight month of declines.

The supply of existing homes available for sale declined by 20% — a major factor in the sales decline. Another factor is that the median sales price of an existing home increased by 19.1% over 12 months.

Likewise, sales of new homes declined by 5.9% in April from March’s level. But the sales still were 48.3% higher than 12 months earlier.

Higher home prices are a big factor in lower sales, pricing some people out of the market.

The S&P Corelogic Case-Shiller Home Price Index increased another 1.6% in March. That’s a 13.3% increase over 12 months.

The index has had 10 straight months of accelerating home prices. The 12-month increase is the highest since December 2005 and one of the highest in the index’s 30-year history.

The FHFA House Price Index showed a 1.4% increase in March and a 13.9% increase over 12 months.

Consumer Confidence, as measured by The Conference Board, held steady at 117.2 in May. But April’s Consumer Confidence Index was revised down to 117.5 from 121.7.

The Markets

The S&P 500 rose 1.53% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.81%. The Russell 2000 declined 0.17%. However, the All-Country World Index (excluding U.S. stocks) added 1.12% and emerging market equities climbed 0.93%.

Long-term treasuries gained 2.21% for the week. Investment-grade bonds increased 1.23%. Treasury Inflation-Protected Securities (TIPS) added 0.14%, while high-yield bonds gained 0.44%.

In the currency arena, the U.S. dollar declined 0.08%.

Energy-based commodities lost 1.30%. Broader-based commodities fell 2.14%, while gold rose 1.69%.

Bob’s News & Updates

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It tells you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

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