On the Outlook for Equities, Why a High-Carb and Low Fat Diet? – Part 2 and World Cancer Rates!

From Aditya RanaDate: Sat, Mar 16, 2013 at 1:58 PM
Subject: On the Outlook for Equities, Why a High-Carb and Low Fat Diet? – Part 2 and World Cancer Rates!


The markets are at an important juncture, with stock indices in the U.S. reaching (or breaking) record highs, but opinion remains fiercely divided between the bears who call for an imminent downturn while the bulls make the case for a continuance of the four year rally. As is usually the case, it is helpful in these times to get the perspective of a market veteran – and few people can do it better than Howard Marks, the Chairman of Oaktree Capital, with an exemplary track-record over 35 years (http://www.oaktreecapital.com/memo.aspx). To summarise:

-Misconceptions about the “equity risk premium” abound – which is defined as “the excess return that an individual stock or the overall market provides over a risk-free rate” – as it can only really be measured on a historical basis.

-The concept of the equity risk premium which really matters is by what margin will equity returns exceed the risk-free rate in the future. However, this number cannot be calculated or derived – in the words of Einstein “ Not everything that counts can be counted, and not everything that can be counted counts”.

-In contrast, a high-yield bond provides a “credit spread” which informs us of the prospective relative return, the riskiness of the bond, its relative attractiveness to other bonds and ultimately whether the bond is rich or cheap.

-To compute the prospective return of a stock requires making assumptions about the growth rate of earnings of the stock to infinity, or alternatively, to estimate the earnings growth rate for a few years and its terminal p/eratio (which will in turn depend on the earnings growth rate from then until infinity!).

-This fundamental difference encapsulates the difference between investing in bonds and stocks – bonds provide a easier to calculate prospective return while stocks require making big guesses about the future.

-When the yearly return on an asset exceeds the rate at which it produces cash-flows, the resulting price appreciation either reduces its undervaluation (and thereby limiting its upside) or increases its overvaluation (thereby increasing its downside).

-This concept is easy to see in a bond – if a bond with a 5% coupon is bought below par with a yield of 7%, and returns 15% over the next twelve months, its expected return over the remaining maturity will be less than 7%. An excess return over a particular period implies borrowing potential return from the future – this principle applies to any income producing asset like stocks or real-estate.

-So when assets appreciate faster than their value grows it should be viewed as a warning sign – to paraphrase Warren Buffet “ when investors forget that corporate profits are unlikely to grow faster than 6% per year, they tend to get into trouble”.

-For example, in 1990 the historic annual returns on equities was 9-10%, but they actually returned 20% per annum over the coming decade – fuelled by credit expansion and the internet boom. So in 2000, professional investors increased their return expectations to about 11% , not realising that the exceptional returns during the 90s was really borrowing from the future (which was then subsequently realised!).

-Looking at the market today – it is important to look at the earnings yield rather than the dividend yield, with the latter understating the return to shareholders as companies pay out only a small amount of their earnings. The earnings yield is just the reverse of the p/e ratio.

-Since WW II, the average p/e ratio has been 16 which implies an earnings yield of 6.25%, and assuming a normal risk-free rate of 3%, it implies a historical risk premium of 3.25% and a yield ratio of 2.08x. However, with the p/e ratio in 2000 at 32, the earnings yield was a paltry 3.12% and with short term t-bills at 2%, it implied a risk premium of only 1.12% and a yield ratio of 1.56x -indicating a strong likelihood of poor relative (and absolute) expected returns for stocks.

-The earnings yield today is back to about 6.25%, and even assuming a 1% risk-free rate (it is actually closer to zero), it gives an equity risk premium of 5.25% and an yield ratio of 6.25x. This is one of the best ratios over the last century (barring the early eighties) making stocks an attractive asset relative to bonds. However, interest rates are artificially held low by the Fed and are likely to be increase in the future which could make stocks less attractive.

-Other factors provide a mixed picture for stocks with: the current p/e ration being slightly below the post WW11 average (pro), cyclically adjusted p/e measures pointing to overvaluation (con), lower expected earnings growth (con), constraints on economic growth and fiscal deficit fears (con), record high profit margins which are likely to decline thereby reducing profits (con), record high corporate cash holdings providing a safety factor and potential for buybacks/dividend increases (pro), investor sentiment remains tepid (pro), market being up 16% last year and up 10% this year (con).

-The current attitude towards equities remain moderate– with equity funds seeing only modest inflows and institutional allocations remain below their long-term averages – making the market susceptible to a continuation of the rally based on even small positive news.

-Thinking of a bull market progressing in three stages- with the first stage characterised by a few people expecting that things will get better, to stage two occurring when most investors start believing that, and then stage three when everyone is sure that things get better for forever – we are likely to be in the first half of stage two.

-Investors are likely to be pleasantly surprised with returns higher than the currently expected 6% per annum, and unless we get deflation, a depression or another calamity, equities should prove to be a much better (and safer) investment than government bonds or high-grade credit.

A simple, clear and yet deeply insightful framework for looking at the current state of the equity markets in the U.S. (and elsewhere in the world). The abnormally low levels of interest rates are making equities look attractive on a relative basis, and the low likelihood of a reversal in the Fed’s (and other central banks) low interest rate policy (at least until June 2015) and it’s QE policy (at least until the end of this year-and probably only in stages thereafter), combined with a gradually improving global economy will provide strong support for global equity markets. As I had mentioned is last week’s letter, stay invested in a diversified manner – favouring quality U.S. companies, EM equities, Europe (in particular peripheral Europe), energy and commodity stocks and high-yield bonds in the developed as well as EM markets.

An interesting chart below (via Morgan Stanley) highlights the importance of keeping short-term real interest rates from moving higher in a significant manner (i.e. above 2%) – as it will significantly increase the likelihood of a recession. This reason, combined with the need to keep the interest cost on the debt low and hence improve the deficit and debt burden, implies continuance of easing policies for several more years.

And as the chart below illustrates clearly (via Sy Harding) – the flows into equities was mixed over the course of 2012 with retail investors withdrawing $152 billion from the stock market while institutional investors only increased their inflows from $67 BN in 2011 to $83 BN in 2012.

However, bond funds attracted sizeable interest in 2012, with almost $75 billion of inflows compared to about $40 BN in 2011. Please also note the minuscule flow into government bonds, highlighting the importance of the Fed continuing its QE programme.

Why a High Carbohydrate & Low-Fat diet? – Part 2.

Last week I wrote about the remarkable life-story of Nathan Pritikin, a pioneer in the field of diet and health, who argued the case for a largely vegetarian high complex-carb diet to battle heart and other chronic diseases. This week I present below the second part of the summary of a path-breaking article (“High Carbohydrate Diets; Maligned and Misunderstood”) he wrote in the Journal of Applied Nutrition in 1976, whichstill resonates today!

-Two studies have shown the impact of a high fat diet on diabetes: young medical students were put into four groups for two days – one on a high protein diet, the second on a high fat diet, the third on no food, and the fourth on a high-carb diet – the high protein diet group tested borderline diabetic, the high fate and starvation groups were quite diabetic and only the high-carb diet group was normal.

-The second study involved using corn oil as the high fat and sucrose as the carbohydrate in varying percentages as diets for 20 year old normal men – after two weeks the 80% sucrose and 5% fat diet tested normal but the second group on a 65% fat and 20% sucrose diet tested diabetic – illustrating the efficacy of a low fat diet in maintaining a normal glucose test even though the 80% carb diet involved using sucrose in the form of table sugar! The high sugar intake did result in steadily increasing triglyceride levels.

-Can a low fat diet reverse diabetes? A study involved using a 21% fat diet on thousands of diabetics in a Montreal hospital over a five year period with startling results – 24% of the insulin dependent patients were taken off insulin, and those still on insulin had their dosage reduced by 58%.

-The Farmingham study, started in 1948 with 5,200 people, indicates that a person with a cholesterol level of over 260 mg has 400% more cardiovascular events than one with levels below 220 mg. The Keys’ Minnesota study, started in 1947, confirmed that the risk of heart disease was directly proportional to the cholesterol level –with patients having cholesterol levels above 260 mg having 560% more heart disease than those with cholesterol levels below 200 mg.

-A study at the famed Cleveland clinic developed a prediction model of artery closure based on three variables; age, cholesterol level and triglyceride levels – showing that at age 28 with cholesterol of 140 mg and triglycerides of 60 mg, only 1/2% would have artery closure, but if the cholesterol level was 360mg with triglycerides of 540 mg, 73% would have artery closure-even at the age of 28!. On testing the model, the prediction scores had a 98% accuracy rate.

-A study on primates involving low fat, high fat and high unsaturated fat diets showed that the monkeys on a high fat diet (with 41% fat) had 58% closure of arteries. When they were subsequently placed on a 4% fat diet and a 40% unsaturated fat diet, the low fat diet showed opening of the arteries resulting in 400% more blood flow while the unsaturated fat diet had 65% less opening of the arteries. In addition, the monkeys which were continually on a low-fat cholesterol-free diet had cholesterol levels of 135mg and no arterial plaques at the end of the 5 year study.

-Two studies demonstrated the possibility of plaque reversal on humans – one 12 year study was conducted on heart disease patients put into two groups of 50 each – one on a normal diet and the other on a restricted fat intake of 15% of total calories (normal being 35-40%) and 100 mg of cholesterol – at the end of the period 38% of the lower fat diet were still alive while all on the normal diet had died. The second study on 280 heart disease patients showed that after four years, the high fat diet group had suffered 400% more deaths and 400% more coronary events.

Next week: on the myth of vegetable protein being deficient!

Came across an interesting new table of cancer rates compiled by the American Institute for Cancer Research (AICR) using World Health Organization (WHO) estimates. According to the new data, the 10 countries with the highest overall cancer rates are provided below. Only three Asian countries were in the top 50 – Korea (24), Taiwan (29) and Mongolia (30), with Singapore at 44 for women’s cancer and Japan at 46 for men’s cancer.

The AICR states that “Lifestyle changes can really make a difference. For example, maintaining a healthy weight throughout life could prevent more than 100,000 incidences of cancer. Eating less red meat and more whole grains and vegetables, which are rich in fiber and a lot of helpful phytochemicals and antioxidants, can help maintain a healthy weight and reduce cancer rates. Avoiding tobacco smoke and sunburns could also help reduce cancer rates”.

1. Denmark 326.1 per 100,000
2. Ireland 317 per 100,000
3. Australia 314.1 per 100,000
4. New Zealand 309.2 per 100,000
5. Belgium 306.8 per 100,000
6. France 300.4 per 100,000
7. U.S. 300.2 per 100,000
8. Norway 299.1 per 100,000
9. Canada 296.6 per 100,000
10. Czech Republic 295 per 100,000

Here is to developing a healthy diet low in fat, high in complex carbs and minimising the intake of animal protein!



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