All US investment performance
advertising is required to contain a caveat that past performance is not a
guarantee of future performance. Some substitute the word ‘indicative’ for
guarantee. Analysts are not as skilled as actuaries in drawing future trends
out of past data, but they, as well as portfolio managers, sales people and
investors take comfort in investing in securities and funds that have performed
well in the past, particularly the immediate past. Increasingly I have a
problem with this somewhat comforting approach.
While cheering for a continuation of a winning streak, those of us who follow
various sports know that
all streaks get broken. One of the many lessons I paid for at the race track
was to avoid odds-on favorites to continue their streaks, and to look for
horses which fit the current race conditions better than their last several win
and loss records. In the current global investment environment I believe we are
currently in a period where simplistic extrapolation of the past may well be
counterproductive.
Counter-indicators
1. In
the first week of the year the value of the yield on long term US Treasuries
was lost in price declines. The stretch for yield has led one bank to recommend
15% of clients’ fixed income to be invested in leveraged loans. As some are
predicting no gain in investing in government paper after the impact of inflation
this year, the relative risk in the fixed income allocation of portfolios is
likely to approach or perhaps exceed the risk in conservative stock portfolios.
(Outside of very low yielding cash there are no large places to hide-out.)
2. At
the end of December the short positions in the NASDAQ Capital Markets were on
average 4.79 days compared to 5.47 days as of December 14th. Part of
the decline could have been year-end trading influenced by taxes including the
expected rise in ordinary rates for some traders and a drop in volume running
up to year-end. Nevertheless a 12.5% drop is worth noting. Most NASDAQ stocks
are more speculatively priced than those listed on the so-called “Big Board”
(the NYSE). They tend to be more volatile. One of the reasons to pay attention
to this data point is that every short position eventually needs to have an
offsetting purchase. Thus a short position eventually means some buying. With
shorts declining there will be less demand for some stocks, not a good sign for
a long-only investor.
3. Large,
in theory conservative, banks and other wealth management organizations are
recommending hedge funds or worse, funds of hedge funds. One bank has
recommended that 20% of clients’ balanced allocations be in alternative
investments (largely hedge funds). Even the sage Byron Wien is recommending 15%
in hedge funds. Some who are looking for a dull 2013 believe that hedge funds,
on average, will earn only mid-single digits. (This pains me as both the
manager of a private financial services fund and an investor in some other
funds. However, I can understand the warning, as financial services mutual
funds on average gained 24.8% and so could give something back, even though
there are other investors who believe that the financials will do well.)
4. With
the increasing loss of independence from political control, some fear that central banks will drive monetary policy to greater inflation. The fears are
that the money created will flow into asset price inflation; for example in
commodities and commodity currencies, emerging market debt and equities. The
fear is that after some speculative surges these assets will crash, taking the
rest of markets with them due to counterparty risks, which will lead to a
significant recession in the 2015/16 time period (or at the end of the current US
President’s political power.) What will happen after that will depend to some
degree on the 2014 and 2016 elections, which will if anything be more divisive
than the past election, particularly as the number of House of Representative
seats that are considered safe has declined to 35 from 105 twenty years ago. A
number of currency funds are taking the opposite view and are drastically
reducing their size in terms of capital and number of employees. (This would
not be the first time that the investment community reduced its capacity just
before a major change in the nature of the market and then scrambled to rebuild
their fortunes.)
5. All
of the above points are relatively short-term oriented and can be classified as
cyclical trends. There are at least three more secular trends that will drive
investments for the next generation and these are;
a) Five
of seven leading countries in terms of life expectancy at birth are relative
hard currency countries. (Switzerland, Australia, Sweden, Canada, and Norway) These
are all exporters that have small populations. The US is far down the list.
However, the demographics of the US are changing rapidly. Would you believe
that California is running out of babies who are needed to fill classrooms with
union teachers and for more workers to contribute to the retiring state/city
work forces?
b) In
the last year of record, the Chinese filed for some 400,000 patents compared to
the approximate US total of 500,000. Contrary to some (and perhaps due to my
exposure to Caltech), I believe that we are entering a period of rapid
expansion in the use of technology, including biotech, into almost every aspect
of our lives. Historically China has been a place of invention and I expect
that their commercial and perhaps military interests will drive the US into responding,
if not leading in kind.
c) Two
recent studies should be the basis for increased investments by individuals and
families. While these surveys are based on US findings, I believe that they may
apply to much of the western world.
i.
A survey of US millionaires showed that
82% believed that their heirs should make their own way financially. Perhaps
driving that view, 31% believed that they will pass on to their heirs less than
what they received. (The latter finding is particularly relevant to families
with multiple generations of wealth that may be drying up.)
ii.
A survey of workers invested in
retirement plans indicated that only about 12% are very confident in their
retirement prospects. (One of my fundamental beliefs why the value of equities
over time will grow is that both at the societal and individual level we will
be investing more into retirement funds. Even if this new money goes only into fixed
income, it will in effect leverage risk absorbing equity.)
What am I looking for?
I long for much,
I hope for little,
I ask for nothing.
-Tasso, 16th
Century Italian poet
Most of the money I am
directly or indirectly responsible for is long-term in nature. With appropriate
levels of cash available to meet current needs and in some cases strategic reserves,
my focus is on investing in good companies that can grow their earnings power
over time relatively regardless of the progress of GDP. On a price/value basis most
often I find these in small and midcap companies around the world. My preferred
vehicle for these investments is in mutual funds and an occasional hedge fund
that possess deep analytical skills with particular emphasis on the application
of disruptive technology.
What are you looking for? Please share.
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