Some people consider me an expert, thus I get lots of investment questions. Usually I can divide the questions and therefore the answers by identifying the depth of investment knowledge and experience of those asking the questions. I find it useful to divide those asking the questions into three broad groups with lots of sub-divisions.
The first group, are often the managers of the funds we choose to consider for investment.
The second group are people who devote little time and effort into financial and investment matters; e.g., the general public.
The third group includes gatekeepers or members of investment committees mixed with pros and others. In many ways this is the most difficult group; those who pose as members of the first group, but in their heart of hearts, they are much more like the public that watch general news or read mass publications. Thus, when I get a question from this third group, looking for a simplistic answer, I don’t know where to start other than saying most specifically ‘No’ or in less than polite society ‘H… No!’ This is followed, if they are really interested, in a discussion of human nature and doses of history and why they are vital investment considerations.
Safe for whom?
Governments pass laws and regulations to promote their own safety and to prevent themselves from being turned out gently or violently by the abused public. If you examine almost all prudential regulations, they are designed to avoid criticism of the regulators. Little or no real efforts are made to help investors to either make good investments or to at least avoid bad exit investments. Bottom line: Gains and losses are the product of human behavior, driven by greed, fear and sloppiness with an accelerator of leverage thrown in to shorten the terminal period. This is the way it has always been and probably always will be.
A historical example
Jason Zweig who is a columnist at The Wall Street Journal, but in reality is a history scholar, mentions in his weekend piece that some 4000 years ago in Mesopotamia there were legal regulations as to future contracts on silver and barley. (I wished I had read them when I tried to take advantage of the apparent mismatch between London Silver and US Treasuries on light margin.) At one of the cradles of our culture, there was an attempt to keep the trading businesses thriving to prevent the losers from destroying the winners and the government. Thus a pattern was ignited that has been repeated by many societies all over the world to “keep the game going.”
A current and controversial example
When a large number of employees who normally vote with their powerful and high spending unions could have lost their high-paying jobs due to mistakes made by management, politicians and unions, it was decided to bailout GM and Chrysler rather than let them go through what private companies would do (an orderly bankruptcy). The US government loaned these and other companies taxpayer money through a pre-packaged bankruptcy that ignored the priorities in the Bankruptcy Act.
Because of this bailout attitude, the government followed a similar practice with the US banking system and at least one large insurance company. These bailouts ignored the history that after similar bankruptcies in the past, new organizations sprung up employing many of the former mid to low level employees at market rates. High priority lenders received reasonable payments, lower credit borrowers or vendors much less and for all practical purposes the equity owners were usually wiped out.
Quite properly voters were incensed by the spending of their money in a way not intended at the time when they voted for President and members of Congress. To prevent future criticism the two administrations and Congress felt they were trapped by “too big to fail” financial institutions. In practice, these politicians followed the old Pentagon approach of planning for the future by fighting the last war brilliantly.
Notice the current US Administration and its immediate predecessor were repeating the failed strategy of the Mesopotamian rulers of protecting the government from criticism, not preventing management and investor mistakes. Today all are free to produce below-market quality products at over-priced levels with inadequate research just as investors are free to hide from their long-term investment responsibilities until the next series of crises. Based on history they are almost guaranteed to occur.
Where are we?
As we entered this year I stated that the odds involved a 20% or greater movement of price. That is either a gain of 20% or a loss of 20% or possibly in an extremely volatile year, both. This is a year that superior tactical skills will be needed for the first two of our Timespan L Portfolios™ of operational needs and replenishment capital. These portfolios should have largely, if not exclusively, easily sold or redeemed securities (funds) because prices are likely to offer more than normal risks and opportunities.
Where am I looking?
I am first looking to sense the amount of investor enthusiasm that is present. There are always some isolated pockets of extreme enthusiasm and desperation. A great deal of enthusiasm will be needed to generate my 20% gains. (Also, this level is needed to create a top from which a major collapse can occur. ) An example of this is the recent price of Tesla which at one point was selling just shy of ½ the value of General Motors. Tesla produces about 90 cars a day. GM makes about 90 cars every five minutes. On a full accounting basis it appears that it will be some time before Tesla can report a regular profit. What is important is that some people are willing to project way beyond 2020 when Tesla is expected to break even and begin to show exponential growth. It has believers. (As they say at the track and in politics, I don’t have a horse in the race either as an owner of either Tesla or GM cars or shares.)
By the way: Tesla's innovative manufacturing can be viewed in this clip.
I am searching for a similar level of enthusiasm for other investments in the years ahead. Possibly I might get sucked into investments falling for the greater-fool-theory trap and hope that I will be able to execute a separation in time. Greater volatility is expected; e.g., on Tuesday the Dow Jones industrial Average moved 424 points.
Since for the first time in many years the market had five consecutive days of losses, I am looking for proverbial canaries in a mine that can signal potential elements of strain. One such item is a much larger than normal decline in the Barron’s Confidence Index of the yields of high grade bonds versus intermediate bonds. The index dropped almost 3 percentage points this week when normally it moves 1 percentage point or less. While it could be a warning because both yields declined (greater popularity), the best grade declined more, 22 vs. 12 basis points. Are the bond mavens becoming worried about intermediate quality paper? These are not the energy-related high yield plays.
As strange as it may seem to most readers, I wonder whether there is a message in the price of gold. If you accept gold as a quasi currency in 2014, it was the second strongest major currency. Even before the Swiss National Bank move, investors have been flowing into Treasuries and Gold. Will these fearful investors prove to be ahead of the crowd?
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A. Michael Lipper, C.F.A.,
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