Sunday, September 6, 2015

What Have We Learned...if Anything?

Personal Perspective

I see the world somewhat differently than most. Perhaps I was always destined to be a securities analyst. Or learning basic analysis at the race track where betting on favorites for every race was a losing proposition. Or being trained the elements of leadership from the US Marine Corps. Regardless of the source of my learning, I tend to examine popular beliefs with a somewhat jaundiced eye. In reading my posts readers would be wise to remember how my thought process works. 


Too much has been written about the causes of the late August declines in global stock and bond markets. The focus has been  almost exclusively on the various financial instruments and economic data. Almost nothing has been written or spoken about the key determinator of market prices. Did a significant number of people all of a sudden get a new insight as to how they should manage institutional or individual portfolios?  In general, the answer is ‘no’ and more importantly, they did not take away any lessons that they should use in terms of structuring their portfolios to be winners over time.

The Current Picture

Going from the most negative to the most positive, comments that I have seen are as follows:

1.      JPMorgan's leading mathematically driven analyst believes "half selling is done." Since much of the selling started with various derivatives it is worth noting that in August the CME reported a 60%+ increase in the volume of index trades. Further while the S&P500 market weighted index declined -6.03%, a version  whose components are equally weighted declined -5.39%. This suggests that large sales of market weighted ETFs (Exchange Traded Funds) contributed to the decline. (This in turn leads me to believe that the August market turmoil was a trading event rather than a fundamentally-driven move.) Put volume exceeded call volume which is also a bullish sign.

2.      A market analyst from Morgan Stanley has commented that the size of earnings estimate revisions have been declining for almost fifty years.

3.      At this time of year Byron Wien regularly reports in his series of exclusive lunch meetings for visitors to the Hamptons. His conclusion is that no one is expecting a recession. (Caution: one of his more perceptive guests commented that the consensus is usually wrong.) 

4.      It is worth noting that according to The Economist there are three local markets that have risen in US dollar terms more than ten percent this year: Hungary +18.8%, Denmark +14.7%, and Argentina +14.5%. I don't remember seeing any of these stocks in emerging market stock portfolios which shows that there are still opportunities for hard working analysts. 

Looking Forward

The second largest California State Pension Plan is electing to reduce its stock investments to 43% from 55%. It is somewhat following its larger neighbor which is pulling out of investing in hedge funds. I view both of these as good news. 

We all search for good indicators to follow. After many years of watching the record of the best positive indicators I have concluded that they are correct only 2/3rd of the time. The inverse of some negative indictors has a greater accuracy level. Thus I view the actions of the two California pension plans as positive.

A somewhat more positive view is expressed by actuaries which are recommending to their clients a 6.4% actuarial rate for pension plans. First, one needs to remember how conservative they are. Second the rate is for the entire pension plan. Assuming a "normal 60/40" split between stocks and bonds and a 4% total return on the bond portfolio would suggest an 8% return for the stock portfolio and a so called risk premium of 4%. The risk premium would drop if bonds were assumed to earn 5% and the actuarial rate remained constant.

One of the guests at Byron's lunches was a CEO of a tech company who addressed the concern that the tech world will run out of big new products or services within thirty years. With what he saw on the horizon if anything he thought technology would be accelerating its progress. 

Perhaps the most bullish and soundest piece of analysis was done by the good people at Charles Schwab. They looked at annual returns of the S&P500 from 1926 to last year to determine the performance extremes for one, five, ten, and twenty year periods.  

Time Period
Extreme High
Extreme Low
One year
+54 %
 -43.3 %
Five years
+28.6 %
 -12.5 %
Ten years
+20.1 %
 - 1.4 %
Twenty years
+14.8 %
+ 3.1 %

These periods can be utilized in our Timespan L PortfolioTM construct.

The longer the time period the smaller the extreme loss, with no loss for the twenty year period. These periods would be appropriate for operational, replenishment, endowment, legacy and custom portfolios. In custom making these portfolios one has at least five different attributes for his or her portfolios which include aggressive, conservative, middle of the road, rigid, and idiosyncratic. These attitudes can be exercised by the selection and combination of stocks, bonds, mutual funds, ETFs, and separate accounts.

What should have we learned?

There is a significant difference between our intellectual financial risk tolerance and our emotional risk tolerance. If we are using an operating portfolio and possibly a replenishment portfolio, we should have been reducing our risk in the first and starting to nibble at the second. As a practical matter (as one of our readers indicated) that procrastination was the mode of the day. This means that for most managers of their own or other people's wealth they have not thus far reached their emotional risk tolerance action point.

There is a good reason for this inaction. They do not believe all the focus on interest rate setting by the Fed and or the latest pronouncements of GDP. Without knowing it they may be practicing Goodhart's Law, introduced to me by David Kotok of Cumberland Advisors. The law states "When a measure becomes a target it ceases to be a good measure." In these two cases (over-utilizing GDP and interest rate data) the poor forecasting ability of the Federal Reserve Board and many of its banks makes one wonder why anyone thinks they could get monetary policy right. The calculation of GDP is not only suspect in China but also in the US as reported recently by John Mauldin. I suspect that many of us are giving additional credence to the fact that we are seeing more people being hired and more jobs that are going unfilled.

The current geopolitical picture is also an element of worry with a Chinese Naval fleet operating off shore in US waters near Alaska, the migration from the Mid-East, and the appeal to populism in many countries, including this week in the UK when the new Labor party leader is elected.

Bottom Line

For those who lack sufficient trading skills and are long-term oriented: stay the course.
Did you miss my blog last week?  Click here to read.

Comment or email me a question to .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of 

Copyright © 2008 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

No comments: