Introduction
Today’s post is a double header with the first part focusing on
thoughts as to the current markets and the second on longer-term issues that
should be considered for investment policy considerations.
I suspect a “Melt-Up”
In last week’s post I discussed three possible directions for the
current market, “melt-up, muddle along, and decline.” At this juncture, for at
least awhile, the apparent path of least resistance is to go up in price.
Positives
There is a belief that surviving a problem that doesn’t kill you makes
you stronger. Most global stock markets
did not fall on the two threats to geo-political peace last week; the downing
of the Malaysian airliner over Eastern Ukraine and the beginnings of the Gaza
strip ground attack. If the markets did not fall, then some believe the path of
least resistance is for stock prices to rise. (Remember it took one month from
the assassination of the Austrian Archduke and when World War I was declared on
the European continent.)
Often when low to intermediate credits rise in price (decline in
yields) relative to high quality paper, it is favorable to stock prices. Each
week Barron’s publishes a confidence index
based on this relationship. Normally it is quite stable. For the week that just
ended the current reading was 69.9% vs. over 74% one year earlier. English
translation is “risk-on.”
Because so many analysts and portfolio managers are relatively new to
the business they tend to look at past history in terms of calendar movement of
the Standard & Poor’s 500 index. They do not recognize that in an average
year since 1980, according to JP Morgan Chase there is a 14.4% decline from
peak to bottom. I am particularly sensitive to 1987 when for the year the S&P
500 index was up slightly but there was a -34% peak to trough decline thru the year, and
much worse in the average stock. In our analysis of mutual funds for our
clients we pay particular attention to the declines of- 49% and -19% in 2008
and 2011 respectively. But who cares, the market always come back.
The consulting community and institutional “gate keepers” pay
attention to ranked performance particularly of short periods. We have
maintained for some time there is little in the way of persistency of good
performance from quarter to quarter and even for one year and particularly for
three years. S&P recently did a study of top first quarter performers for
the first quarter of 2012. They compared these winners to the top 25% winners
for the similar quarter two years later. They found that only 3.78% of the
funds repeated in the top quartile. What were even worse were the large
capitalization funds where only 1.9% repeated. Remember large cap stocks have
more analysts following them than smaller companies. What this suggests is that
the market may well be shifting to favor short-term momentum winners which
would be leaders in a sharply rising market.
Ignoring what you don’t like
If you can ignore facts and views that are cautious, one can become
more bullish quite quickly. Some of the subjects that investors seem to be ignoring
are:
1. Private Equity Funds are
selling their holdings at high valuations.
2. Lust for yield is forcing
investors into less conventional-higher risk paper.
3. People seem to forget
that most Merger & Acquisition deals work out poorly for continuing
investors. That it took so long for Steve Forbes to find an acquirer for the
majority of his company shows that the private equity buyers are more cautious
now than the public investors.
4. Interest rates are rising
each week, for example: 15 and 30 year mortgage rates, new car loan rates and
the banks’ cost of deposits (MMDA). At the same time numerous banks are
reporting, as forecast, lower quarterly earnings and are looking to new markets
to replace their crunched earnings power, e.g. PNC. This is occurring in a
period when people are saving less and the spreads between high and low credit
quality is narrowing.
5. Many US investors are
turning to Europe to find good investments. This surge in demand has led to a 102%
increase in Western Europe High Yield issuance in the first half of the year. (Anytime
there is an increase in low credit quality issuance I wonder when we will see a
meaningful uptick in defaults.)
I Accuse
This is the famous title of an open letter to the President of France
by Emile Zola about the “Dreyfus Affair” which eventually led to Captain
Dreyfus being exonerated and a public recognition of societal biases in France.
In a far less dramatic context I accuse my fellow members of the global
financial community of complacency. While we all see any number of troubling
events, most do not change or plan to change our investment positions. In
effect many have elected to play “the greater fool theory” card in an
undisciplined way. A few of the things
that should cause at least some of us to begin to shift away from risk of loss
of capital are as follows in no particular order:
The sale of the Russell indexes to the London
Stock Exchange opens more questions as to the future value of index production.
Internally both the US and Canadian central
banks are looking for methods of improving their research in private
recognition that they have not been very good.
We are seeing considerable “flight capital”
movements. In the US the net sales of international funds is increasing as
domestic oriented funds are in slow growth or net redemptions. In Europe we are
seeing that the bulk of the long-term fund sales are not in funds from
cross-border managers and are often going into investments outside of their
domestic market.
Some very visible investors have made the following statements:
Carl Icahn:“This is the time to be cautious.”
David Kotok: of the esteemed Cumberland Advisors indicates that tapering is now
going to be tightening.
Kathleen Gaffney: Well-known bond fund manager now of Eaton
Vance* noted that traditional bonds have interest rate, credit and
liquidity risks which is shoving us into unconventional paper.
*Stock owned by me personally
and/or the private financial services fund I manage
An example of a real concern of mine is the discussions of an informal
group of retirees, semi-retired and active portfolio managers, analysts both
fundamental and technical, and an experienced institutional salesman. In
periodic meetings, from my viewpoint, too much of this group’s discussion is on
the issues of the day (often political) and not enough about individual
securities and portfolios.
This group may well be a microcosm of the investment community trying
to get the last high price for what they own while wringing their hands as to
problems facing the investment world. Within
my own responsibilities I have only recently started to sell long held
positions, but still are very much an investor in equity funds and some
individual stocks, mostly in the global financial services arena.
What we should be doing if the melt up gathers momentum is to place
sell orders at various different levels so that we maintain our survival
capital for the next major bull market, which I expect beyond the next five
years.
To my readers at Citywire Global
Thanks to my City, UK and European readers for once again making my
blog one of your top choices. Last
week’s post was listed as Number One of the five most read stories on Citywire Global. I appreciate your readership.
Question of the Week: Do you have any specific plans to liquidate some
of your “at risk” assets?
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Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
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All Rights Reserved.
Contact author for limited redistribution permission.
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