Sunday, April 24, 2016

More Opportunities from Disruption + Confusion


One of the relatively consistent habits of people in the global financial community is an insatiable focus on the current price trends and almost no focus on factors that may reshape their workplace. I see this right now, but I should admit by nature I am a contrarian and that I often focus on what I see coming over the horizon.

Financial Services Employment

Knowing people within the financial community I am conscious of an increasing number of senior employed executives looking for new opportunities and those recently “at liberty.”

Over the years this has happened a few other times and in most cases my friends have found new and profitable activities. During these periods I have said that based on the available people, on paper, I could form one of the best financial groups in the business. (The reason for the “on paper” caveat is knowing the personalities, I am not sure all of these experienced people could work well together.)

I perceive we have entered another and perhaps much larger such period. Recently I have had conversations with presidents of large and small investment funds groups, senior traders, strategists of various types, etc. Part of this personnel reduction is due to present and projected profitability squeezes. Part may be due to low (relative to the past) prices for financial organizations. As an investor in financial services stocks I am used to seeing this kind of cyclical behavior. Too many people within the financial community believe that their own value is similar to whatever is the current growth stock leader.

The problem of risk management is tied to the growing illiquidity in the markets which is addressed by Jamie Dimon on pages 19 and 20 in the JP Morgan Chase annual report*. With his personal worry about abrupt rise in interest rates, it is likely that markets will become more illiquid and some traders and investors will be shouldering more risk.
*A personal holding. I will be happy to send those copyrighted pages to subscribers who contact me. 

Using the often used phrase “This time is different,” I think we may be entering a new phase. For many years we have been going through a concentration phase largely through mergers or acquisitions. This trend could well see a reversal in the next couple of years and the individual investor could be the loser.

Government Interference in Compensation

On both sides of the Atlantic as well in selected Asian countries governments are interfering in the compensation practices of large financial organizations. Officially the politicians drive is to reduce the risk taking that leads to government bailouts. (A far better way to do this is to prohibit such rescues by the politicians in governments and particularly in their central bank dependents in sponsoring bailouts.) The latest action by the US government is to require those in senior jobs or those in a position to assume risk to have the bulk of their income to come from deferred equity ownership that will vest in 4 to 7 years and be available for recapture for cause.

New Enhanced Trading Groups

I suspect the real motivation on the part of these bureaucrats is to address their concerns for wealth inequality both on the personal and corporate levels. The initial rules are built on a scale with the greater the assets owned the more draconian the implications. The focus is on principal trading. If these regulations are fully implemented it is where the job and profit opportunities will be created. Instead of the bulk of trading being conducted on exchanges and by the members of the concentrated players, it will shift to smaller asset owners who control large amounts of clients’ money; e.g., Hedge Funds or similar non-deposit taking groups. These groups will have no obligations to the marketplace and/or to provide service to individuals. In effect we will have reinforced the kind of private markets that currently run most of the commodity and real estate markets. The new enhanced trading groups will need research for both decision-making and institutional marketing. Some of these groups will gather money through accounts, others may use private vehicles that that have similar characteristics to mutual funds.

Historically any attempts to legislate risk has only shifted to other locations including beyond borders. Thus the aggregate total of risks assumed is unlikely to change. People’s business cards and the location of some of their computer servers accessing the Cloud will change. By the way, the biggest source of risk for most citizens is the induced risk that is inherent in current government practices; for instance deficits, unfunded liabilities, and unaccounted for contingent risks.

The Enthusiasm Watch

As repeatedly set forth, I am on the watch for growing enthusiasm for stock prices as a warning device of a major top. Here are three cautionary signs:

  • Only three of forty-four markets tracked by The Economist declined in the week ending April 20th.

  • Both in the US and Europe mutual fund investors are putting money into Fixed Income funds and out of Money Market funds showing a lack of Jamie Dimon’s concern about rising rates.

  • Barron’s Big Money Poll of global money managers has 35% bullish and only 16% bearish with 49% neutral. However 59% are bullish on commodities. (They must have high confidence in their individual selection skills for their outlook for corporate profits this year is under 5% and under 10% in 2017. This suggests reliance on concentrated, less diversified portfolios.)

Standard Approach to Look for New Winners

One of the lessons I learned from an old market pro was to search the new low list for future winners. This is why I insisted on showing the lagging funds much to the annoyance of fund managements when I was publishing Mutual Fund Performance. I still believe it is a good exercise in the search of future winners. This view was reinforced with the arrival of Dimensional Fund Advisors' Matrix Book.

Near the very end of this interesting compendium were two pages that looked at twenty years of relative performance of developed and emerging markets which I found to be instructive. Below is a table for the last six years of the best and worst performing countries in these two universes:


New Zealand  

My data analysis points out how rare there is a repeat with only USA having a next year winning repeat and Austria and Spain repeating on the downside later.

Much more important in the emerging market lead, both Hungary and Egypt went from the worst to the best in a few years time.

Using the Hungary/Egyptian model I would be looking for opportunity in both Canada and Singapore.

Question of the week: How do you search for future winners?     
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A. Michael Lipper, C.F.A.,
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