Introduction
One
can divide people into two groups: the insecure and those that attempt to
manage their insecurities. As we get older we all make physical, psychological,
political, and financial mistakes among others. Almost all veteran investors
are insecure to some extent about their investments. Because of our
insecurities we look for guidelines to avoid making bad mistakes. Unfortunately
we often ignore guidelines and signs with which we disagree. Instead, we search
for guidelines and signs which we agree.
Smart Money
Due to
our investment insecurities we search for and want to follow "Smart Money."
Those people that are recognized as being successful as investors have
so-called Smart Money in their investments.
One of the reasons in my prior life as a provider of mutual fund
performance information that I was frequently quoted in the press was that the
media and other pundits wanted to identify winning funds in order to
focus on what those funds were doing at the time. Rarely was the discussion about how
they were smart.
As part of my investment management responsibilities for clients, when I interviewed various "winning " portfolio managers and some of their key analysts about both their thought processes and their selections, I was disappointed. All too often their research was shallow and focused only on incremental changes of significance. In many cases their current success was due to market rotation and relative value compared to then-popular securities. Some analysts and portfolio managers were truly perceptive and were deep thinkers. In my search for enlightenment I found a number of very smart investors who were not in the public eye. Often these and some of the portfolio managers of publicly traded funds did mostly their own research and were not reliant on brokerage research. On the other hand, I was unimpressed with those that followed the portfolio changes made by Warren Buffett, Peter Lynch, John Templeton, and John Neff. Their reported activity was sufficiently delayed from the time of transactions and at different than current prices. Further, their purchases typically fit their specific portfolios needs.
As part of my investment management responsibilities for clients, when I interviewed various "winning " portfolio managers and some of their key analysts about both their thought processes and their selections, I was disappointed. All too often their research was shallow and focused only on incremental changes of significance. In many cases their current success was due to market rotation and relative value compared to then-popular securities. Some analysts and portfolio managers were truly perceptive and were deep thinkers. In my search for enlightenment I found a number of very smart investors who were not in the public eye. Often these and some of the portfolio managers of publicly traded funds did mostly their own research and were not reliant on brokerage research. On the other hand, I was unimpressed with those that followed the portfolio changes made by Warren Buffett, Peter Lynch, John Templeton, and John Neff. Their reported activity was sufficiently delayed from the time of transactions and at different than current prices. Further, their purchases typically fit their specific portfolios needs.
One
approach to finding smart money is the basis for a good bit of technical market
analysis. In a flat or down market a stock price (along with an increase in its
volume) goes up, which can be recognized in charts, there is a belief that
someone or a group knows something that the rest of the market does not.
Therefore, they may be smart money. We will only know when the surge in its
stock price ends.
Weight of
Money
I was
introduced to the importance that some professionals place on "The Weight
of Money" many years ago as the leader of a group of analysts on a global
trip largely focused on mining investments. When we were in Australia, one
evening I got a call from a client of our firm from Tokyo who intently
interviewed me as to the reactions of the analysts to various companies. After
we talked for quite awhile I asked him why he was so interested about the
analysts’ reaction rather than what I learned about the companies. He had a
very good global internal research department and probably was the best single
client of most institutional brokerage firms. Further, both he and I recognized
that while my analyst companions on the trip were more than competent, they
were not for the most part "the lead" analyst in the stock.
Our
Tokyo-based client explained to me that the change in the amount of buying or
selling in a stock could have a disproportionate impact short-term on the
price. The weight of money rather than fundamentals could have more impact. As
he was a manager with traditionally very high turnover in international
markets, his focus on the aggregate views on a stock made sense to me.
The
Weight of Money Can Mislead
Often
what could properly be described as the weight of money is mistakenly labeled
smart money. There were three instances in the last week when the weight of
money might have given investors the wrong signal. The first two operate out of
the best single investment laboratory that I know in terms of practical
analytical skills. Early in the week it was reported that the British
bookmakers had an 85% belief that the Prime Minister would get the mandate she
wanted. This was foolishly taken as an analytical conclusion. Bookmakers have
no particular forecasting skills. What the 85% represented was that 85% of the
money wagered on the election saw a significant Tory victory. I suspect that
the majority of the money bet came from in or around London and was not
geographically dispersed. Bookies made a similar miscall in terms of the
BREXIT referendum.
The
second misread was the betting on The Belmont, the longest race for three year
horses in the US. The beaten favorite
came in second with final odds of 5/2. (Which means if the horse wins, the
bettor wins $5.00 for every $ 2.00 bet.) The winner paid $5.00 for every $1.00
bet or twice the amount on the favorite and was the second favorite. At the
racetrack, the pari-mutuel payoff is similar to the old bookmaker’s calculation
of the different level of moneys bet less taxes and track compensation. This is
a dollar weighted input. With only a cursory look at the local newspaper’s
pre-race article, my intellectual choice was the eventual winner in part
because he was more rested than the favorite and there was enough early speed
in the race that the favorite and a number of other horses would be slowing
down in the home stretch when the leading jockey in New York was giving a
brilliant ride on the winner. Favorites don't win often enough to pay for their
losses.
The
final misread from those who rely on the weight of money argument occurred on
Friday which may be an echo of a substantial decline of many years ago. Up to
Friday the five following stocks: Facebook, Amazon, Apple*, Microsoft, and
Alphabet (Google) represented 41% of all the gains earned by the stocks in the
Standard & Poor’s 500 through the end of May. Thus 59% of the gain came a
net basis from some 495 other stocks. While these five were not the most
heavily owned stocks in the index, they were substantially owned. One study
indicated that among large mutual funds, over 80% of them owned at least one of
the five. Many probably owned Apple as it is the stock with the largest market
capitalization. On Friday these five as well as many tech companies fell more
than many other stocks, even though the Dow Jones Industrial Average was up a
little bit. It is possible for awhile that the five may give up their
performance leadership as part of normal rotation.
* I have been a long-term holder of Apple shares in a personal
account.
Perhaps
the five are the modern equivalent of "The Nifty Fifty" which was a
group of approximately fifty stocks that out-performed the general stock market
from the late 1960s into the peak in 1973. As with the current five, The Nifty
Fifty started their ascension coming out of a bottom. Most stocks reached their
peak in 1968 but the averages did not top out until 1973-74 period. While there
is some disagreement as to which stocks were in the fifty, the criterion was either
a JP Morgan list of one decision stocks (only buy, never to sell) or the
highest price/earnings ratios. There was a great overlap between the two lists.
A number of the companies had very bad investment performances after the peak.
Some were merged out and a few filed for bankruptcy. However most survived and
a some prospered; e.g., Walmart.
I do
not know what the future holds for this year's five leaders. I do know that if
a portfolio has only a partial interest in the five, below the commitment in
the various indices, it is the equivalent of being short that particular name if the name rises in price
relative to the index. Historically, the stocks with the highest price/earnings
ratios can fall the most. On an immediate basis Friday's decline closed the
remaining price gap which made the best performing index, NASDAQ, vulnerable.
An
Important Caution
S&P
Global has lowered the credit rating of Massachusetts because it has not been
building reserves that were required by the state legislature. This should be
viewed as a general warning that eventually there will be a need for these
reserves. It may be a number of years away from a significant economic
recession with a market decline. I am sure that it will happen, as it always
has as a correction from too much leverage in the system. I am not worried
about the aforementioned five stocks, as most appear to have large cash
reserves. I am concerned about others who
often have an increased demand for their services when the general public are
having difficulties. In some cases this
could cause partial or total liquidation of their investment portfolios. The
time to add to one's fortress is when the sun is shining.
Questions of
the Week:
1. What Smart Money signals are you finding?
2. Is the weight of money important to you?
3. Are you building your reserve?
__________
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A. Michael Lipper, CFA
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