Perception vs reality

 By Guest Blogger Doug Rowat

If you recall, Perception Versus Reality is a recurring post where I take aim at widely held investor beliefs and then outline why these beliefs are mistaken. Here’s my latest debunking (with, appropriate for this week, a Stan Lee cameo).

Perception
Volatility is up sharply this year—+94% as measured by the Cboe Volatility Index (VIX). Investors can simply buy and hold one of the many available VIX exchange traded products to protect their portfolio from market choppiness.

Reality
At latest count, there are 15 exchange traded products that are linked in some way to the VIX Index. If you miraculously have the ability to accurately predict short-term periods of US equity market volatility then these products may be of some use. For example, the iPath S&P 500 VIX Short-Term Futures ETN (VXX), the largest VIX exchange traded product on the market, jumped more than 40% in October. However, none of these products are able to mirror the VIX exactly, so as a point of comparison, the VIX itself was actually up 75% in October. Further, if your holding period is any longer than a month, and often only longer than a few weeks, these products rapidly begin to implode.

Roll costs and contango (subjects for another day) are a few of the reasons for their horrific long-term performance, but regardless, VIX exchange traded products are not meant to be bought and held. They do NOT represent a one-and-done portfolio panacea against volatility. They must be monitored constantly, are extremely volatile—often 10x more volatile than the broader equity market—and are only suitable for highly speculative investors. See below, you can quite easily lose your entire investment if you hold these products long term. Also, they’re costly by exchange-traded-product standards, many with expense ratios north of 1.5%.

VIX exchange-traded products are deadly if held longer term

Source: Bloomberg, Turner Investments. Table includes the 3 largest US-listed products and the largest Canadian-listed VIX product. The widely-held SPDR S&P 500 ETF is included as a point of comparison.

Perception
Wall Street market analysts are highly skilled and their consensus forecasts are usually correct.

Reality
Unfortunately, in terms of being predictive, the consensus opinion isn’t useful. I’ve highlighted before the following observation from New York Times columnist Jeff Sommer:

Since the start of 2000, the Standard & Poor’s 500-stock index has ended in negative territory in five calendar years (2000, 2001, 2002, 2008 and 2015) and has been virtually flat once (in 2011). But while a handful of individual forecasts have, from time to time, predicted mildly negative years for stocks, the Wall Street consensus in every single year since 2000 has predicted a rising market.

Consider the calamity of 2008. … The S.&P. 500 fell 38.5% in the course of those 12 months…the forecast for 2008 was unusually bullish, calling for a rise of 11.1 percent. Wall Street missed the mark by 49 percentage points that year.

So, collectively, Wall Street strategists are terrible, but equity analysts covering individual companies aren’t much better.

One of my frustrations when I joined the investment industry 20 years ago was the absence of ‘sell’ ratings on the companies under coverage by equity research departments. Institutional equity analysts almost always had a bullish view of the companies that they followed. But how could this be? Stocks traded lower all the time, sometimes trending down for years. Eventually, I came to understand the corrupting influence of investment-banking relationships and the importance of analysts maintaining rapport with company management teams. The end result was (and usually still is) few, if any, sell recommendations. The below example of analyst coverage of Enron typifies this pattern. It wasn’t until Enron’s share price had almost completely collapsed that we saw the first negative ratings appear. Not exactly helpful for investors.

Enron analyst ratings (columns) versus share price (yellow line): almost a complete collapse occurred before the first sell ratings appeared

Source: Bloomberg. Green = buy, yellow=hold, red=sell

Perception
And, finally, in honour of comic book legend Stan Lee who died this week at 95:

The Atlantic recently asked the important question: who is the most underrated superhero of all time?  The responses ranged from She-Hulk to Aquaman.

Reality
All wrong. The most underrated superhero is Shang-Chi: Master of Kung Fu. Why do I mention this in an investor blog? Because regular readers know that I’m a supporter, in moderation, of alternative investments such as comic books, and Special Marvel Edition #15, Shang-Chi’s first appearance from 1973, is an undervalued comic, particularly in top condition. See those black borders below? Highly condition sensitive. Also, don’t underestimate the big-screen potential of these more obscure Marvel characters (witness the success of Black Panther, Ant-Man, Doctor Strange, etc.). And, if you can find a SME #15 signed by Stan the Man, so much the better.

Shang-Chi: the most underrated superhero of all time

Source: Ebay. The author doesn’t currently own any comics related to Shang-Chi: Master of King Fu, though he did collect them extensively as a kid. He talks comic books but doesn’t literally talk his own book.

Until next time, this has been…Perception Versus Reality.

Excelsior!

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.