Introduction
The First Commandment
for all investors is to play to survive.
In my discussion of the
Legacy Portfolio part of the Timespan L Portfolios®, I suggest including
stocks and funds that focus on being disruptive to the established order.
Thinking deeper about the attributes of disruption, I know we have entered a
disruptive age.
If you are a keen
observer you will see that almost every major activity is experiencing some form of disruption.
In virtually all areas we are trained in some classical way of thinking derived
from past successes and failures. The neuroeconomists at Caltech assure me that we make important
judgments on the basis of our or others’ experiences. We like to follow
patterns. The problem with this comfortable approach is that in many spheres
there is disruption. Just look at Science (colliding black holes creating time
warp evidence), Economics (experimental quantitative easing), Politics (populism
usurping establishment roles), and even some money managers. Our instinctive
reaction is at first to reject the disrupters and then fight them as they are
threatening our classical way of thinking and operating. What we should be
doing is examining the facts/data and trying to understand the power of their
proponents. Whether the disrupters are right or not they may represent an
opportunity. They may not be completely wrong, and without rigorous study we
may not recognize when they are more right than our older models.
This is far too big of
a series of subjects for me to thoroughly deal with now. Because I feel that I
have some responsibility to those that have used various investment performance
measures to select mutual funds and other managers based on their past records (which
for a period of about a year have been underperforming) this set of disruptions deserves
some attention. I am going to briefly review what is in the process of changing
which may explain what is now happening and more importantly what may happen.
Sound Bites
Look at almost any
front page of a newspaper or the first story on a so-called news broadcast. The
strong odds are that it will be negative in terms of life, limb, and the
pursuit of happiness or gain. We need to understand that the media has discovered
that negative sells. The people who believe that principle the most are the
politicians. In almost every country they are focusing on the problems as a way
to attack the “they” who need to be replaced by a different set of politicians.
Interesting that each day many if not most things in this world get a little
bit better.
Last week I devoted
most of my blog post to the annual letter from Warren Buffett as edited by
Carol Loomis. I, and others, found the letter to contain reasons to be bullish
in the long-run. In her letter this week to her largely retail audience, Liz
Ann Sonders stressed a preference for what Mr. Buffett was saying rather than
the politicians and their pleas of misfortunes if they are not elected. The
statistical odds favor investing in US equities in the long-run.
The Cost of Regulation
Around the world banks
and other members of the financial community were blamed almost exclusively for
past financial crises. To prevent repeats without reforming the political
leadership, the financial community and particularly the large banks were subjected
to intense and costly regulation. Due to this additional regulation banks need
to increase their capital at all levels. The higher the value placed by the
market, the belief is the better the future results and the lower the cost of
raising the required capital.
According to Standard
& Poor’s the price/earnings ratio of the banks in its 500 index is 12.38 X
where the P/E for the banks in S&P's small cap 600 Index is 18.51 X. Thus the
smaller banks have to give up less of their equity to get capital than the
larger ones. In a period of manipulated low interest rates banks will have
difficulty making enough money to attract more capital to make more loans. One
of the disruptive forces being unleashed are non-bank financials that are less
regulated and often less transparent. Thus the portions of the economy that
need loans will likely get their loans with less regulations but at higher
interest rates. In Europe banks are
often less well capitalized and in some cases have materially larger
non-performing loans relative to their assets.
Most private businesses
get their money from local banks. In the US, businesses approaching mid size
have the option of publicly issued paper. This would be a new experience for
many European companies which they may find disruptive in terms of disclosures,
costs, and tax implications. On the other side of the coin, retired individual
pensioners are not earning enough on their deposits to meet their living needs.
So their senior lives have been disrupted.
Price of Oil Links
Disruption can be
positive or negative in terms of direction and whether one is a natural buyer
or seller. The more established participants are in the camps of lower prices
for longer. Moody’s has just lowered the credit rating of many Gulf and African
government bonds. T Rowe Price New Era Fund which maintains half of it
portfolio in energy stocks views that the price can descend into the twenties
from the current prices in the thirty dollar a barrel range, rebounding for a
longer term target of $40-50. Sounds bearish, but in February the leading
developed market broad market index performer was Canada +4.27% compared with
S&P’s measure for the US of ‑0.28%. (For many years, I have hedged my
investments in US domiciled mutual fund management company stocks with some of their
cousins above the border.)
Another link to the
disruptive changes in oil prices are many securities in the emerging and
frontier markets. In general, as a group they have fallen in sympathy with the
fall in imports into China. One of the reasons for the decline in energy prices
is a cutback in its imports of oil and other raw materials. Based on their
valuations close to the lows of the prior cycle, they appear to be “cheap.” They
may be cheap, but not a bargain. In revamping the Chinese economy its import
needs may be permanently altered which would certainly be disruptive to buyers
of these stocks.
How to Invest In a
Disruptive Period
During disruption, most
of us mere mortals do not know how things will turnout. We do know that we are
in a period of rapid change at many levels. While we may return to the pre-disruption
stage, it won’t be really the same because in the back of our mind we know that
there has been a disruption and others could come.
The standard investment
strategy in dealing with risk is to diversify into different instruments. Most
investors do that within various individual securities. What we do for clients
is to offer a better way to diversify. We assemble a specific portfolio mostly
of mutual funds from different managers who think differently about market
conditions, risks and opportunities. All too often even those who are early
recognizing a problem or opportunity only see a portion. Hopefully we can
assemble a task team that can get a fuller picture and thus give us and our
clients more confidence in dealing with disruptions.
I would be happy to
discuss how to deal with the disruptions that you perceive.
Question of the Week:
When was the last time before an important election you were correct as to what
the newly elected leader was able to deliver?
________
Did you miss my blog
last week? Click here to read.
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 MikeLipper.Blogspot.com
Copyright © 2008 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
All Rights Reserved.
Contact author for limited redistribution permission.
Posts
No comments:
Post a Comment