Sunday, December 4, 2016

University of Investing Through a TIMESPAN Lens

“Today, if there is a run out of US Treasuries because of the Volcker Rule and Dodd-Frank,
 there is not enough liquidity at current prices.”


I feel that each day is the first day of attending a very learned university. In my case it is a University of Investing. I search each item that crosses my screens, my desk, or interactions with others for possible meaning for my clients or my family's investments. Every day there is so much to learn that without some attempt to organize the inputs one can get overwhelmed. Thus I am suggesting that the inputs be organized into class structures as if one progressed from basics to advance courses. After the confusions from the recent elections, including (as I compose this blog) the Italian referendum allow me to demonstrate how I place inputs into a somewhat organized structure.

Freshman Level

It is at this level one learns basic principles that one applies throughout life. One could do far worse than to have as your initial investment professor Jason Zweig, the erudite columnist for The Wall Street Journal. There is wisdom in his opening sentence to this week's column on the attractiveness of small-caps. He wrote, "When markets go way up, your enthusiasm should go down." This wise cautionary statement should be applied to all asset classes and individual investments. Applying this to various popular leaders also may be wise. Remember in both the sports arena and the political world the crowd’s purpose is to build up a person or an idea to an untenable height to then have the pleasure of watching them fall. Coming out this class one should believe in moderation. One needs to be prepared for some failures along the way, which does not signify that in the long-run our hero or heroic idea will not work out.

No freshman year should be complete without some field work. It is important to identify what other people think. More importantly it is critical to learn whether opinion leaders should be believed. Thus, the next course might be devoted to the various Pew surveys, in this case reported on by Kopin Tan of Barron's. When asked in terms of trust, the respondents indicated their level of trust was 33% in the military, 24% in medical scientists, 5% in media, 4% in business leaders and 3% in politicians. As a US Marine now in civilian clothes and a senior trustee at Caltech, I believe in the ranking order if not the numerical results. I wonder where the average academic would place? The investment lesson drawn from this survey is to focus on what people actually do and what they can do by themselves.

Sophomore Year

This is often the period of students knowing it all because they believe that they have decoded the world and know what is actually happening. They have learned that this has been a difficult performance year, particularly beyond the popular mechanical averages. What they may not appreciate is that there were many ways to produce above average returns. There were eight separate mutual fund investment indices that produced double digit returns as of Friday. The lead was Small Cap Value +22.82% which was followed by a number of other small, mid caps, and multi-caps both value and core. More interesting to me that in addition to these, both Large-Cap value and Equity Income made the double digit list. This suggests to me that while being in the favored asset class helps, individual security selection was also important. A somewhat similar conclusion can be derived from examining the ten best performing fixed income fund categories. In the year to date period when the average general US Treasury fund had a 0.61% return, there were ten taxable fixed income objectives that gained between 4.26% and 11.34%. The top five were:

Fixed Income Objective
Year-to-Date Performance
1.  High Yield funds
2.  Emerging Market Debt Hard currency
+  8.78%
3.  Loan Participation
+  7.96%
4.  Multi Sector
+  6.17%
5.  Emerging Market Debt Local Currency
+  6.08%

To show the trading mindset one can look at this week's flows into specific Exchange Traded Funds (ETFs). The second largest inflows were to First Trust Industrial/Producers Durable + $740 million and the largest redeemer First Trust Consumers Staples -$707 million. This suggests that main players in  ETFs are trading not investment organizations and as they grow and narrow their focus they can be a disruptive influence on some stocks some of the time.

Combining the first two sophomore class lessons, one of the best technical market analysts is close to calling the end of the thirty five year bull market in US Treasuries. As essentially an equity investor, I am worried of a repeat of what happened to emerging markets debt and equity when Russia defaulted on their own Treasuries. While this was a specific isolated problem, trading desks that owned them found that they were substantially below minimum capital requirements and sold whatever they could to get back into capital compliance. Today if there is a run out of US Treasuries because of the Volcker Rule and Dodd-Frank, there is not enough liquidity at current prices. Thus various banks, brokerage firms, and leveraged hedge funds will sell what they can to meet capital needs which means they could be massive sellers of equities. This condition may never come to be, but a rumor of it could cause almost the same level of damage. For the moment in one part of the fixed income market there is some lessening of risk. Moody's* has reduced its estimates of high yield default risk.
*Owned personally or by the financial services fund I manage.

Upper Classmen and Women

Once the students get closer to graduation from their protected environment they should be focusing on jobs both in general and specific for them. The pre-lawyers and pre-politicians in the class will be quickly disappointed to find in various constitutions that there is no requirements to create jobs or preserve them from economic realities. For some time students and their academic advisors believed that this was the function of the reigning government and if not this one, the next one. In a global world the reality is that government using its tax power on present and future generations does not have direct ammunition to create all the desired jobs. As my fellow Caltech Trustee and neighbor pointed out to me in a well reasoned reaction to last week's blog, (copies available for the asking), that the US has been shedding manufacturing jobs since the 1950s and Western Europe, Latin America, and Japan are following. It is his guess that China has or will soon enter this phase.

There is a growing need for employees in the service sectors. The problem that I see is that these openings are not being currently filled. The cover story is that the applicants don't have the requisite skills. My experience as an employer is that too many of the applicants don't have the right attitudes of providing honest service to customers, fellow employees, supervisors, and owners. Far too many don't know how to budget their time, money, and efforts. They don't show respect to others that is the foundation of a successful service operation. Today we all are competing with international competitors and we need to respect them as well. I suspect that today's students will need to adjust their working life plans. In southern Europe the current official working life is 33 years, in Northern Europe it is 38 years. I have been working for sixty years and expect we should prepare today's students to plan to work in service industries for forty-five to fifty years.

Senior and Graduate Studies

Often one of the parlor games after a sports or political team loses is a post mortem as to where to assign blame. I remember a lot of books and words generated as to how we "lost" China. The plain truth is we never really understood China and never did own it.  As investors we need to come to grips on why China is gaining more power. It actually starts for us in an elementary school practice no longer being followed. In school every month we had to contribute savings from our allowance to a local savings bank account. We were being taught savings. This is not done today. As a matter of fact, one of the critical differences between us and Asians is their aggregate savings is about on-third of their GDP. In the US and Europe it is closer to one-fifth. Play out the benefits of faster capital growth and a materially-oriented younger population.

This is one of the reasons that I believe that the results both for good and less so will pivot on the events in China and the rest of Asia. From an investment standpoint we need to hedge our own success with some attention to them.

On a longer term basis after we get over the focus on job creation and preservation, when are we going to see organizations that will gain political prominence because they represent consumers and possibly another group representing savers?

After Graduation

Through these four phases of investing education you can see the logic behind our approach to TIMESHARE L Portfolios®

Sunday Night’s Headline

 Euro falls sharply against the dollar after Italian Prime Minister Matteo Renzi suffers a heavy defeat in Sunday's referendum.” There is a need to study more in terms of implications for near-term investing in Europe.  This could well be similar to the immediate Brexit decline and snap-back.

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