All of us want the stock market to rise, particularly the ones that our clients and we own; that is unless we are net short or have a disproportionate portion in cash. While Mae West, the burlesque queen said too much of a good thing is wonderful, wiser advisers have suggested that people should be careful for what they wish. A number of commentators have said that the current rise in the stock market is the least loved bull market in memory. It is unquestionably lacking enthusiasm.
I agree that on the surface the general public is not enthusiastic about the stock market. Market peaks are characterized by great bouts of market enthusiasm. Previously, I commuted into Manhattan from the suburbs with an individual in a well paying position who one day announced that he quit his job and would be sitting at home and would be day trading one particular dot-com stock which he said would provide him a handsome wage. His financial fate and those of his kind are well known. Others have described similar historical periods as the madness of crowds. I suggest that most important peaks are so characterized.
Up, Up and Away
Regular readers of these posts are aware that while I believe that we are, for the moment, in a melt up, I am concerned that the next eventual decline could be severe if selected market prices rise in the short-term in a parabolic fashion (1>2>4>8>16). Managers of long-term funds producing rates of return 2-3 times the normal (ten year rates of return) will be fired in favor of mysterious managers producing gains, at least in the short term of 5-10 times normal rates. When these “hot hand” managers no longer deliver they and much that they invest in will plummet.
There is considerable enthusiasm today within the professional and pseudo professional communities as we have pierced various prior statistical barriers. In previous posts I discussed the term “handles” used by the news media to describe various breakthrough price levels expressed in round numbers. The three big handles recently touted and their handles were the S&P500 (2000), Berkshire Hathaway* ($200,000 for the “A” shares), and Apple* ($100 on the 7/1 split shares). A fourth one may well be looming in Alibaba ($100).
*Shares owned by a managed private fund or owned personally
The proper job of a professional investment manager and analyst is to look underneath the enthusiasm. There are elements that need to be understood and may be of concern in each case mentioned below.
The recent rise may be a function of an extreme amount of money being invested by institutions into ETFs tracking the index. Popularly it is believed that hedge funds and other aggressive investors are the main drivers. In the last week investors only redeemed net $0.6 Billion in domestically focused mutual funds, in the same week ETFs had net equity sales of $6 Billion of which $5.7 Billion went into the largest, S&P 500 ETF.
Berkshire Hathaway - $200,000
Unlike last year it is likely that Berkshire’s published book value and unpublished intrinsic value will rise more than the S&P 500, as it is already doing. Most equity oriented institutions are underweighted in the stock and some feel that they must catch up.
Apple - $100
While the stock is reacting positively to the various new product and service announcements, I believe the gently rising stock price is in part due to a massive buy back program. Ruth and I visited The Mall at Short Hills twice over the weekend to check out the lines not only at a massive Apple Store but also smaller, but still busy Verizon and AT&T stores. What impressed me in all of these stores was very sound and pleasant crowd control. They know what they are doing.
All four of my older personal Apple units have now been upgraded to the new iOS8 software and we are seeing already important improvements. From my particular point of view Apple is not an equipment producer and seller, but a creator of annuities which can probably go on long after the neat new products are no longer annual events.
Alibaba - $100
The high NYSE price on its opening day was $99.70 which could well set up the Alibaba $100 handle. There is enough which is not fully fathomed about the company as well as China that a highly volatile future is likely.
Contrarian Corner: Hedge Funds
There was a negative column on hedge funds in Sunday’s New York Times indicating that a very large California state government pension plan intends to exit some $4 billion dollars they have invested in hedge funds. I suggest that this may well be a clarion call for those sophisticated institutions and some individuals that have not invested in hedge funds to begin their hedge fund research in earnest.
The keys to understanding a hedge fund
Probably there is more misleading information about hedge funds than any other financial community topic. While there are services that track those funds that are willing to be tracked, people do not understand that hedge funds are not an asset class that has well defined rules and regulations. The key documents in the relationship with a hedge fund are the various agreements with the investors which are not necessarily the same for all investors. Because of the perceived profitability to the managers of hedge funds, they have attracted some of the best portfolio managers, analysts, traders, and sales people from both mutual funds and broker/dealers. The attraction has been too great! Thus the ability to distinguish one fund from another has narrowed. We are seeing a number of hedge funds retiring from competition either because they were not successful enough or they made too much money so their principals could retire from client-facing work.
The market environment has not been favorable to many of the past ways some hedge funds have made money. A number of funds in the last couple of years have underperformed, particularly when compared with market indices that were inappropriate measures. Using an average performance measure often gives an inaccurate picture of skills. For example, I was recently made aware of the three year cumulative performance of funds investing in India. Goldman Sachs* came out on top with a gain of +19.1% and worst was -8.4% by a fund managed by Jupiter*, taking a mean of 5.4% tells us nothing about the two extremes and more importantly as to how either will act in the future.
We may well be on the cusp of a new period where the skills of hedge funds could produce good results. First instead of a low interest rate environment, Moody’s* believes that we are coming to an end of the period of cheap credit. Already one of the measures that I look at daily is the average interest rate paid by banks on deposits which has gone from 0.38% to 0.42%, which indicates that banks are making loans above the rate they can earn leaving their money with the Fed. This changing environment will introduce opportunities for significant rewards and risks particularly in the intelligent use of leverage. Notice in the discussion above the underlying elements of the market could be significant opportunities through more volatile markets. A retired very successful short seller tells me that profitable short selling is something of a lost art. In the aftermath of greater enthusiasm which will drive prices too high, the art form may resurface.
My thoughts are biased because I serve on a number of investment committees that have used hedge funds successfully in the past. Further, my private fund could be considered a hedge fund, because we can sell short. We haven’t done so in many years as we thought there was, in general, more to gain on the upside than on the downside.
How to play in an enthusiastic arena
As most of you are aware we recommend the use of Time Span Portfolios (Operational, Replenishment, Endowment, and Legacy). The portfolios that have time horizons of five years or less need to be able to use the expected volatility to their advantage or at least to avoid major losses. The longer term portfolios should be conscious that from time to time there may well be attractive bargains available.
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A. Michael Lipper, C.F.A.,
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All Rights Reserved.
Contact author for limited redistribution permission.