Monday, September 5, 2016

Shorter-Term Worries, Longer-Term Opportunities


We are not enjoying complacency about securities' prices, we are suffering from petrification. One of the supposed benefits of holidays be they secular such as Labor Day, bank holidays or religious fast days, is it gives investors and those who are dependent upon investors a chance for introspection.

On the surface we are experiencing relative calm with the month of August posting the second lowest volatility in a decade of S &P 500 performance. I have yet to meet any professional or individual investor who is happy with the markets - stock, bond, or commodity. The relative lack of movement is anything but creating complacency but rather a deep seated fear of being wrongly positioned for the next market. Until magically they see further into the future than they are now, investors are petrified to act.

Short-Term Worries

Several new books and other long treatises can drone on as to all of the problems facing our global societies, economies, political leadership and securities markets. I am going to list a number of concerns that occurred to me over this three day weekend and it is not an exhaustive list:

1.  Over-valuation of leading components of popular securities indices due to flows into passive portfolios, including ETFs. These buyers are participators not evaluators.

2.  A record level of long contracts on the Dow Jones Industrial Average. (This level of speculation is normally wrong. However, in today's world I wonder how many of these contracts are paired with shorts on individual stocks.)

3.  Moody's* warns "take cover if defaults climb through 2017."

4.  John Authers of the FT in suggesting rules for investing success, recommends the need to be humble as the markets are not perfectly efficient and the greater the price paid for a security the lower the potential return.

5.  In a recasting of the famous economist's view of a “Minsky  Moment,” the illusion of control encourages risk-taking behavior. Much of what is being pitched these days is expressed as low risk due to the fact that they are government actions and in the past history few things have gone bad.
*Held in the private fund I manage.

In the latest Marathon Asset Management Global Investment Review, the London-based firm tells the story of a famed Soviet professor of statistics who regularly did not take shelter during the Moscow air raids in World War II. When asked, he pointed out that there were seven million people living in the city and one elephant living in the Moscow Zoo. Thus he felt comfortable not going into the shelters until one night he showed up at a shelter. He then announced that the prior night they killed the lone elephant. The message: Change when the facts change.

Longer-Term Opportunities

This weekend I sat next to another guest at a wedding; she had worked in development at Yale before it was famed for extraordinary investment performance, but during the period that it was building that record. We chatted about the Chief Investment Officer who had introduced alternatives to stock and bond portfolios. We concluded that one of the reasons for Yale's success during that time was that few or any of its major academic competitors were taking advantages of these opportunities.

During the current period of complacency/petrification I see a similar opportunity. Too many very bright investors are focusing on the current (apparently insurmountable) problems and not at the opportunities that always exist but too often are hidden to us because of our perception deficits.

Keith Ambachtsteer contributed an article to the FT entitled "Long-term thinking will lead the way to improved returns." He knows by experience in affecting a number of Canadian and to a lesser degree, US pension funds. His focus is to keep the attention on the long-term and not get bogged down in the short-term.

If one does focus on the longer-term, an investor has two mathematical advantages working in his/her favor. The first is the compounding impact of reinvesting income. Over the last five years the reinvestment of distributions from the stocks in the Dow Jones Industrial Average raised the DJIA total return by 33.85% over its simple price change gain. The second mathematical power going for investors in the long run is that almost all of our lives we have been in a period of secular growth with both demographics and technology helping to enlarge the demand for what we produce.

During a period when the negatives are being accentuated, too few people are searching for positive opportunities. In the US and some other countries, we will have both new political leaders as well, I believe, quite different legislative bodies. Perhaps we will also have some movement in the judiciaries. As much as many would like, they are not going to be able to slavishly copy what was done in the past. Even slight changes will create opportunities for those who are looking for them. Major changes can create major opportunities. I believe we will see many. 

While it may be too early to tell, one should look for ways to foresee changes in both the labor and consumer markets. As an example, keying off this weekend's news of the poor showing of Germany’s ruling party in Angela Merkel’s own district due to the rise of an anti-immigrant party that has potential implications in Germany, the rest of Europe and possibly the US.

How to Play

During these uncertain times I believe our preferred structure of sub portfolios addressed to specific time spans can be of particular value. Regular readers may be familiar with my TIMESPAN L Portfolios®.  I would suggest that the need to meet payment requirements over the next couple of years will require close, very short-term management that is extremely sensitive to changes of credit conditions and shifting short-term interest rates. (The first, or Operational Portfolio.)

The replenishment requirements of the expended operational funds (the second or Replenishment Portfolio) probably need to deal with at least one down market year before the new government leaders leave office. On the other hand, investing for endowment (the third portfolio in the series) and other intermediate and long-term money have a great opportunity to invest wisely in less popular investments. For the truly long-term investor there will be ample opportunities to invest in both new and established disrupters.

Question of the week: Please help me find disrupters, what are your current favorites? 
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A. Michael Lipper, C.F.A.,
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