Introduction
The
mission of a good investment analyst is to think about the impossible thoughts
or at least the ones that seem improbable to most. The job of a prudent portfolio
manager is to anticipate problems in the face of increasing momentum.
In last week’s post I
raised concerns about a forthcoming peak or top of the global stock markets.
This week I see more signs beyond the increase in margin debt I highlighted
last week. I doubt that I (or anyone for that matter) can call the top with any
precision. Nevertheless, I am concerned that we are much closer to a peak than a
five year-old bottom and increased caution is warranted.
My
concerns are outlined below. I would be happy to discuss these items with members of this blog community.
Black Friday:
Traditional research could be failing
Long-term
readers of these posts are used to my shoe-leather research of going to the near-by
“The Mall at Short Hills” on Black Friday. This year my wife Ruth, my niece Alisa
and I went to the glitzy, largely high-end mall Friday afternoon. Parking was
less difficult than on other Black Fridays. With exceptions, both the shoppers
and the stores were tight with their money. Relatively few people were carrying
four shopping bags at once. As a matter of fact, this year there were many mall
“walkers” and some in lounge seats without any bags at all.
I
only noticed one shop advertising for additional help. The only two stores that
seemed to have any frenzy around them were the Apple and Verizon outlets, both sellers of Apple products. (One should be
careful, even analysts and portfolio managers see what they want to see. I am a
long-term owner of Apple* stock and we buy these products through
the Verizon store.) In past years these perambulations gave me a good clue as
to how overall Christmas sales were going. I now question this approach as
there is some chance that on an overall basis there will be more sales over the Internet
than in the physical stores in 2013; if not now then surely next year. We
should have an easier time finding a parking place next year.
Mutual fund signals
One
should expect because of my history and portfolio that I would pay attention to
what is happening in the mutual fund business. In October investors added a net
$21 billion to Equity funds as compared with a net redemption of $16 billion in
October of 2012. For the ten months the net flow was $134 billion compared to a
net redemption of $99 billion in the same period last year. This money probably came from a $221 billion smaller net contribution
into Taxable Bond funds and a net swing into redemption from net sales in
Municipal Bond funds of $91 billion. What has me concerned is that the biggest
increase both percentage-wise and dollar impact was the $115 billion increase
in World Equity funds followed by $104 billion increase in total sales by the Capital
Appreciation funds. Both of these groups typically assume that the fund owner
will be able to redeem quickly from these more volatile type funds. Only $67
billion was added this year into the less volatile and more likely retirement money
of Total Return funds. Adding to these concerns was that most fund channels showed
increases in October over September, except the institutional channel and the
proprietary bank channel. I am concerned that the lower sales in October in these
two channels could have to do with the restructuring of the marketplace in anticipation
of the so-called Volcker rule restricting proprietary activities of banks.
In
addition, Variable Annuities are seeing net redemptions across the board except
for the Hybrid and High-Yield investment objectives, which suggest that even in
this supposedly long-term arena for retirement, investors are looking for
performance in some risky places. (All of the numbers quoted are sourced from
the Investment Company Institute.)
My
concern about market restructuring can be gleaned from information re-published by John
Mauldin on the number of pages of major financial laws. The list is arrayed chronologically
and also inversely as to their lasting importance: Remember the more pages, the
less effective the legislation becomes.
- Federal
Reserve Act (1913) 31 pages
- Glass
Steagall Act (1933) 37 pages
- Graham-Leach-Bliley
Act (1999) 143 pages
-
Dodd-Frank
(2010) 2319 pages
All
of these bills created hurdles in the end and at great expense defeated the fundamental
purpose of each legislation, but made a lot of money for lawyers, including those
who had service on Capitol Hill.
Portfolio
managers cherish their investment records as well as having concerns for the
long-term benefits to their shareholders. The obvious fear on their part after
a number of years of good to great performance is concern about a less good if
not an outright nasty future. In some cases of over 40% gains this year,
certain Small Company funds are closing their doors to new money or new accounts.
The latest one to announce this softly is T Rowe Price* New Horizons
fund who has executed this move a number of times in its long and distinguished
history. Other Small Company funds have built up their cash holdings to over
40% and in one case, it is reported, to 65%. We are increasingly finding it
difficult to find growth-oriented funds, particularly Small Company funds that
meet my standards of research and prudence for our fiduciary accounts. As the
market rises on more enthusiasm, it will be more difficult to pick long term
winners.
Two-handed economists
and portfolio managers needed
While
a former US President once sought a one-handed economist, an economist that shows
the proper degree of balance is actually more worthwhile. The control of the
leading Central Banks of the world is now in the hands of those who believe
that no mess is quite so bad that official intervention won’t make it worse, asserted
the UK's Daily Telegraph. In this era of
multiple quantitative easing (QE), some academically driven measures can work.
Over the weekend Moody’s* upgraded the Greek Government Bond rating
from “C” to “Caa3” with a published view that after six years of the economy
contracting that in 2014 there will be some growth and by 2015 the Greek
economy will be rushing ahead at a 1% growth rate.
Two
missing important caveats should be added. First there is no measure of the
long-term impact of exporting brains and labor to be employed elsewhere with
little probability that they will return. The
second point: to a market observer the
Moody’s announcement is not a surprise as both the markets for Greek bonds and
shares have been rising for some time.
The
lead/lag effect between the markets and the economy needs some explanation
to many who are not deeply involved with the market. I will share with you a
synopsis of two conversations about this dichotomy I had in a 24 hour period.
The first was with a confused cousin who is a graduate of a well-known university
who also has a locally obtained master’s degree. She was confused as to how the
US market (where she has some investments) could go up, and the economy be so
bad that her sales of a professional product were not up to expectations. I
asked her whether she had two left hands. She said she had a right and a left.
I asked if there are there times each hand is doing something different. My
comment was that the market and the economy were like her two hands each
performing different tasks. This apparently made some sense to her.
Saturday
night at a reception for donors to the New Jersey Symphony Orchestra (an
organization lucky enough to have my wife as its Co-Chairman), I was talking with
a senior staff member who had a similar question. I suggested that we would not
want our Concertmaster who is a world renowned violinist switching places with
an equally professional timpanist for an important piece of music. He got it
that in terms of harmony one needs both, but they play different roles. That seemed
to satisfy him.
Buy, Sell or Hold
Howard Marks, the CEO of Oaktree Capital, a very successful investment
management firm, and a friend for 30-plus years believes that markets are forever cyclical and those who do
not expect future cyclicality are at risk. At the moment, while cautious, he is
not calling a top. I am also cautious, particularly because my private
financial services fund last week had a gross year to date gain of 34% which is
high for a quality-biased conservative portfolio.
Nevertheless
for clients I am responsible for making decisions or at least suggestions.
Thus, I have to make Buy, Sell, and Hold decisions. As mentioned in previous
posts I array my decisions along the different time horizons. I am, for the
most part, reserving my buying to stocks that appear to have substantially more
long-term upside than shorter term downside.
My
Selling is largely driven by cash funding needs, rebalancing within agreed-to
guidelines and in anticipation of some current holdings enjoying upward momentum,
but which have a history of significant drops when the markets turn nasty as
they always do. For long-term oriented endowments and my own family I favor Holding,
as I believe the underfunding of global retirement capital will lead long-term
capital flows into the markets that will produce good results for long-term,
prudent investors.
*Disclosure: Either owned
personally or in my private financial services fund.
Please
share your thoughts with me on these topics.
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