Sunday, December 16, 2012

Three Bullish Presents for Investors

This is the holiday season of giving presents. I have three ideas as presents for long-term, fiduciary oriented investors. These ideas are both presents for those who may need them as well as thoughts that should have presence in an investor’s mind while looking into the future.

1.       Waiting for the big drop

At a recent dinner with a knowledgeable member of a charity’s investment committee, he indicated that he was out of equities for his personal account which is to fund his living expenses for the next twenty years. Yet he was perfectly comfortable with our use of equity funds for the charity. In terms of estimating future returns, I believe my actuarial friends will see little difference in a twenty year and a theoretical perpetual return for the charity. While I recognize and expect the past price patterns to continue, this suggests that in any ten year period, there will be three 25% declines from peak levels. Further, once a generation there is likely to be a drop of 50%. Having experienced these in the over fifty years I have been an investor as well as serving other investors, I know very few market participants that totally side-stepped these declines. I have found it to be more difficult to accurately guess how big a drop will occur once a decline is underway. I have looked over my notes and recollections of my judgments at or near past bottoms. In every case I convinced myself that a deeper bottom was required to bring the market to a bargain basement level. There were always lower estimates of earnings, unfounded rumors of firms, institutions, or well-known individuals that were in dire straits which would become known soon. As difficult as it is timing a bottom price, the decision to buy early on the way up is even more difficult. Because at the time of the sharp decline there was no market-clearing event which would signify the end of the bear market, most lacked sufficient courage to be an early participant on the rise. Often this rise was described contemporarily as a rise in a bear market caused by successful short covering, not the beginning of a new bull market, or at least a sustained stock market rise.

While some may have all the skills of identifying a major decline in advance, recognizing a bottom, and being an early participant in the recovery rally, along with most other professional investors, I do not have these capabilities.  As with many extreme sports, and other dangerous pursuits, I choose not to engage in market timing strategies.

Perhaps more importantly, there are a number of positive features I see on the investment horizon which can be summarized as follows:

A)      The largest gains come from investing into opportunities when others retreat from challenges.

B)      A careful listening to the press conference given by the Federal Reserve Chairman will reveal his view that the monetary policies being followed have not lowered unemployment (and underemployment by those seeking full time work or discouraged workers). I would suggest other countries’ quantitative easing also has not produced significantly positive results. I believe that market and credit rating declines will eventually curtail the need to sell more government bonds to the central and commercial banks. As usual the private sectors, including individuals, are ahead of the government sectors. While governments are issuing more bonds, the private sectors are deleveraging. In the future we may see the private sectors expanding while the government sectors begin to contract. One of the lessons for an equity investor is to look to the bond market for clues to the future.  Each week Barron’s publishes a confidence indicator that measures the ratio between the yields of mid-quality bonds versus high-quality bonds. The index normally moves 1% or less in a week. When the index goes up, which means mid-quality bonds are going up, it is bullish for stocks. In the last week the indicator rose by +1.4%. Bottom line: I would be leaving cash for equity.

2.       Economic bears like stocks

As is often the case, Jason Zweig in his Wall Street Journal columns, reports on thoughtful pieces he has read. This week he reviewed the opinions of two astute thinkers on the economy who see that the US progress will labor to grow at half our historical rate since the Civil War. Nevertheless, both are investing in high quality US stocks. One of them, Jeremy Grantham of GMO believes that such a portfolio will grow for the next seven to ten years at an annual rate of 5% plus inflation. This is a very satisfactory rate as it exceeds many institutional and endowment minimum spending rates. Many conservatively managed pension funds will be able to meet their needs with such returns.

3.       The biggest potential present from Singapore

One of the investment managers that we use for our accounts is Matthews Asia. As one would expect, they are long-term bullish on Asia. In their well-reasoned November Asia Insight letter, entitled “Emerging Asia’s Rising Productivity,” they focus on the smart way to use labor rather than the initial low wages, which are now rising. Part of the reason for the rising labor productivity is the attitudes of the local governments. The Singapore Department of Manpower has a vision statement which states the department “embodies the aspirations of lifelong learning and the need of Singaporeans to adapt, learn and re-learn skills, attitudes and competencies for lifelong competitiveness.”  Now compare this view to that of the US Department of Labor’s mission statement: “To foster, promote and develop the welfare of the wage earners, job seekers, and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights. While we can understand the historical political development of each institution, the US Department of Labor raises lots of hurdles to generating high productivity in the US labor force. Indonesia, which has a population that is much larger than Singapore’s, has a similarly charged Department of Manpower. Some of the US Department of Labor activities are good for labor (and in the long-term, capital), but many are anti-competitive. Maybe we will make some future progress by following the emerging market leaders as we recede.

Investment Implications
·        Don’t attempt to time the market.
·        For the long-term, equities are better than cash.
·        Some of the emerging markets understand how to produce long-term value and selectively belong in many portfolios.

Please share your views.   
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