Introduction
To
some degree we are similar to a group like teenagers enjoying our first kiss.
This communication skill has set us up to be exposed to other kisses. Turning
to our social, political, and investment lives we are regularly being planted
with kisses. Unfortunately those kisses are from those who wish us to part with
our approval, votes and money. As they besiege us with kisses as translated
from their sales training exercises “Keeping It Simple Stupid” (KISS).
I am
particularly turned off by oversimplified presentations or sound bites by
various sales types, be they be politicians, salespeople, and especially client
portfolio managers and other types from wealth management organizations. It
is normally a mistake to interrupt them as they have to go back to their opening
line and repeat their pitch. Don’t ask too many detailed questions. By the time
one gets to the third level of questions or cross examinations they are out of
their depths. The good ones will stop there and change the subject to more
familiar topics. The others will guess which “solutions” can be amusing but
have little lasting value. Nevertheless, these presenters do have worthwhile
value. They are excellent at summarization and generating memorable quotes.
Before
I select a mutual fund for my clients I need to spend time with the fund's primary
portfolio manager. I ask lots of questions, some they may have not addressed
before. The purpose of the exercise is to assure me that the portfolio manager,
perhaps aided by analysts, knows more than I do and has some different views
than I do. I buy funds when it is clear to me that they bring materially
added value. Often these portfolio managers are not as memorable or glib
compared with their professional presenters. I still remember spending close to
two hours with a well performing fund manager peppering him with lots of
questions. At the end of the time allotted I looked at my list of questions and
did not have any answers to my questions. What was clear: I did not understand
him well enough other than to appreciate his good record. Subsequently when as
all good managers do, he had some less than stellar performance, he left the
large fund group with a couple of accounts as it became clear that the group was
only interested in good performance not the reasons for it. It took many years
for me to return to this particular shop. On return the new group of portfolio
managers were good communicators of their bottoms up analysis.
The
Necessary Three Inputs
One of
the better market analysts that I know is asking his clients to be emotionally ready
and to be prepared to act in the future when the markets become much more cyclical
with major changes of direction.
In order to prepare for
these changes I believe a good investor will need three inputs. The first is
understanding the “big picture” scenarios of the top/downers. The second are the
contrary indications from the bottom/uppers. The third is an individual risk
management levels for different components of one’s entire investment and
career portfolio. In this stew one will need to be judicious in what one eats
and when, without the tempting need to consume all that is “on offer.”
Top/Down Stock Market
Views
Charles
Schwab’s team is expecting a pull back from current levels. This is overdue in
that the S&P500 has not had a 5% decline in over a year. The only strategy
in using elements in the “500” to decline in the second quarter was the
S&P500 High Beta sub index. It was the second highest performer in the
twelve months through June which clearly demonstrates the rotational or
cyclical nature of the market. The level of enthusiasm does not yet fulfill a
prerequisite for a major top; the American Association of Individual
Investors' (AAII) consensus in its weekly survey had a bullish jump to 35.5%
from 28.2% the prior week and a bearish count of 25.8% from 29.6%. Clearly most
participants have a neutral view. This and other sentiment indicators are worth
watching at least as coincident measures and when they go to extremes as
contradictory signals.
Bottom Up
Inputs
Contrary
to popular views of many of the various pundits, mutual funds are beating “the
market.” Each week my old firm, now known as Lipper Inc., an affiliate of
Thomson Reuters, tracks fund performances of mutual funds around the world. For
investors in SEC registered funds, it divides its list into various investment
objectives. In the latest week it is tracking 69 equity oriented fund
objectives. For the year to date period ending Thursday the average performance
in each equity oriented fund investment objective was better than the
performance of the average S&P500 fund in 39 investment objectives or 56%
of the universe.
In the
US Diversified Equity (USDE) group there were five better performing
objectives, four were growth funds of various market capitalization levels.
There were 9 sector objective winners, in addition 25 of
out 26 world equity fund objectives were also winners.
The
latter is not surprising as fund investors and their advisors have been buying
non domestic funds for over a year while their older and more long-term fund
holders were completing their USDE voyages to meet educational, retirement and
estate needs. What is interesting and historically surprising is in the same
year to date period there are 27 fixed income investment objectives with
fluctuating net asset values. Every one of these averages were positive. One of
these, the Emerging Market Local Currency average (with a gain of 11.45%) did
barely beat out the S&P500 gain of 11.39%.
Often when stocks go up, bond and other fixed income securities decline
in price.
An
Important Breakout Despite Clues of a So-Called “Likely” Pullback
Some
of the leading technical market analysts are pointing to the fact that both the
S&P500 and the NASDAQ Composite have twice broken out on the upside with
gaps. These are usually filled in before there is an extended move. This is
underpinning to the belief that a pull back is likely.
A
reversal to the reversal may be imminent. In the backing and filling of the NASDAQ composite index, NASDAQ created
a classic “head and shoulders” reversal pattern which often presages a reversal
of the former pattern, which was rising. However, instead of declining,
the
index is rising - if it continues for a little bit more it
could create a reversal to the prior reversal pattern and predict an important
breakout for the NASDAQ. This is of
great interest to small cap and technology investors and could stimulate even
greater enthusiasm for their holdings.
The
level of naivety expressed by much of the various talking heads about the
changes in US regulations and taxes is a bit breathtaking. If Congress is
instituting the changes it is likely that the bill will be hundreds of pages
long. If that is not daunting enough, the number of pages of specifics
including contradictions will be a multiple of the legislative documents. For
instance the controversial and badly drafted Dodd Frank Act (DFA) was 848 pages
and the subsequent regulations totaled 22,000 or a ratio of 25 pages of
regulations for each page that was finally passed into law. Remember currently
the bulk of the employees that will administer these regulations are not
sympathetic to the current US Administration. Further, when the new laws and
regulations come before the Supreme Court or possibly the lower courts, they
will review the testimony given to the relevant Congressional committees.
Thus,
when and if we get a major piece of “tax reform” enacted, my fear is that the
amount of taxes that my clients and I will pay will go up not down as the
reductions of deductions and permissible expenses will cancel out any tax rate
reductions.
Emotional Preparations
First
I accept that I will not perfectly predict the peak or the beginnings of a
major decline. Hopefully I won’t be too premature or too late. My primary
defense mechanism is my TIMESPAN L Portfolio® philosophy
where I can expect to be able to be defensive in certain parts of our holdings
and are willing to continue to hold other parts having our large gains
converted into significant unrealized losses. One can accept these unhappy
results if there is sufficient capital (largely cash) in the operating
component. Without scaring them too much, I try to get clients to do the same.
I accept a certain amount of substantial career risk and position myself to be
able to pick up bargains during the chaos.
__________
Question of the week: How are you emotionally preparing for
future economic and market declines? They
will certainly occur, perhaps sooner than expected.
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A. Michael Lipper, CFA
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