Sunday, February 15, 2015

Reading the Market Surge


We all look at the world first through the lens of our experience. Even while I was still on active duty in the US Marine Corps I read Barron’s weekly whenever I could find it in oversea ports or posts within the US. While the articles were of interest, the back part of the magazine had and still has within it the most comprehensive pages of weekly market and economic data. When I started to look at mutual funds as clients for my research analysis pieces some fifty years ago, I tried to create a similar compendium of fund data. Thus, today I look at the global stock and bond markets first through reviewing fund data to get my bearings.

Six weeks into 2015

Dow Jones has combined a good bit of the Barron’s data with its own statistics and includes in its online Market Data Center mutual fund indices and investment objective averages from my old firm. Through Friday the 13th of February there are four fund types that are up between 3% and 4 %. These are three growth-oriented fund groups that are labeled Growth funds investing in various sized market capitalizations, excluding Small-caps; plus a fourth group investing in Science and Technology companies. The only fund classification to show better results, (surprising to some) are the International funds, up 4.14%. What implications do I draw from the data?

Growth vs. Value

Over very extended periods of time those funds that follow the growth religion produce roughly the same long-term results as those followed by the value investors. To the extent that value does somewhat better, it may be a function that in their portfolios there are stocks that are acquired while growth companies (using their higher valued stock) are the acquirers. The plain truth, on balance, is that acquisitions don’t work out for the acquirers. However, the rotating performance leadership between growth and value investors can inform investors as to where we are in the sinusoidal, or if you prefer, cyclical market unfolding pattern. The single most important touch point for a value investor is current price relative to the estimated intrinsic value of the company. The growth investor's first focus is what the future is likely to bring to the investment under consideration. In markets that are fearful of a return to periodic declines, the pragmatic skills of the value investor are rewarded. They are very much “now” people. The growth investor lives in a world of expectations. These two polar opposites lend themselves to the currently popular designations of “risk on or risk off.”

"Risk On" phase

Have we entered a risk on phase? The Growth fund leadership suggests we have. The NASDAQ market index has rallied more than the more senior exchange indicators. (Part of that is due to the preponderance of Science & Tech plus Biotech issues listed there which may suggest that in time Small-cap Growth funds will be part of the leadership group.) The broadest gauge of the US market, the Wilshire 5000, went to a new high last Thursday. Other “Risk On” indications may be in weeks of rising US dollar values, when mutual funds are regularly seeing redemptions of domestic-oriented funds and money pouring into International funds. One doesn’t do that if one believes that globe’s leading equity market will be collapsing. Even Bond funds are participating in the move to take on more risk with flows into High Current Yield portfolios and withdrawals in some other types of Bond funds.

Is this bullish or bearish?

The plain answer is both. Markets rise on the basis of renewed hope and accelerating expectations of very positive future results. As regular readers of this blog may remember, I have felt that the lack of great enthusiasm has protected us from more than a normal 25% or so drop which regularly happens in most decades. For a bigger decline, of a once in a generation type, we will need to draw many more people into participating into the enthusiasm. Some will quit their day jobs to trade the market. Families will rearrange their long-term safety nets to participate in new wealth and advanced spending. This is not happening yet.

Future clues

The fund flow data mentioned above has within it some useful clues. The aggregate data mentioned includes both the traditional mutual fund data and their newer and more institutionally-oriented Exchange Traded Funds (ETFs) and similar products. While the combined data is showing “Risk On” characteristics, it is  being driven by the materially smaller ETF community and by much more active, trading-oriented hedge funds and similar managers. In many cases these traders are relatively short-term holders of these vehicles as they are using them as substitutes for more expensive futures with less liquidity. A much better clue will be the morning coffee klatch and cocktail parties and social receptions where the loudest talkers will be bragging about their “brilliant purchases of individual securities or hedge or mutual funds.

Individuals: What to do?

To your own self be true. Individually most of us have gone through a number of downturns and thus tend to be more value-oriented than growth buyers. Stay with what you know and be prepared to pick up deep bargains if they appear. Others that are schooled and comfortable with science and technology can have a reasonable portion of their wealth in growth and have the wisdom to understand and take advantage of periodic disappointments.

Institutions: What to do?

As investment committees are made up of individuals with different backgrounds and investment proclivities, some combination of the two approaches is often the best. The approach that we recommend has to do with our series of time span portfolio constructs. In both the Operational and Replenishment Portfolios it is reasonable to assume a market decline is coming followed by a recovery. In view that we have not had a shakeout since 2009, one should be expected. These two portfolios should be as small as possible to meet current and replenishment needs. More of the sound, long-term institution's needs should be in the Endowment Portfolio with a time horizon of fifteen years and the Legacy Portfolio for the next generations' needs. These portfolios should not be utilizing market timing approaches and should invest for the long run.  By definition there are too many sold out bulls in a recovery.

Question of the Week: Will your current portfolio wisely handle the next bull and bear market?

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A. Michael Lipper, C.F.A.,
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