Long Term Investors Are Too Short Term: The Key Question is ‘How Long is the Race?’

Introduction

As the readers of my posts already know, I learned critical elements of security analysis and portfolio management by handicapping thoroughbred horses at the New York racetracks. In deciding on which races to wager on as distinct from just observing, the key decision was to guess how fast the race was going to be run. Further, some guesses were helpful in terms of the segments of the race. Through this analysis one could determine the probability of which horses were likely to be in the lead at important times and whether horses that normally run from behind the crowd had enough time to catch up and be a leader at the end.

Do you notice that almost all discussions of supposedly long-term investors are focused on the present or the very immediate future? Can you remember an instance when we have seen the best performing stock in early January be the best for the year, or much more importantly the best stock for ten or more years?

Investing for grandchildren can help the picks of the grandparents

At a recent investment group of semi-retired and fully retired portfolio managers, chief investment officers and senior fundamental and technical analysts almost all of the talk was how these remarkably experienced and smart investors focused on their own accounts as they dwelt on how they saw the current investment picture. The general conclusion was sobering which led  many of the individuals to only a few possible purchase decisions, without much in the way of changes made to their existing personal portfolios.

In an attempt to bring greater value to the discussion, I asked that we focus on investing for our grandchildren. In that line of thinking, I asked the group to show by a raised hand how many thought that in some period at least ten or twenty years in the future would we see US Treasury interest rates above ten percent, the vast majority of hands went up. I suggest that this view is more important in setting policy than whether the esteemed Dan Fuss of Loomis Sayles is right in his intermediate projection for ten year US Treasuries at 4.25%. The key point is that this “horse race,” which is indefinite in length, is likely to be run differently than our memories of past performance.

Change of data has unrecognized impacts

Those who follow the races should take into consideration a change of equipment on the horse. The following changes are probably under appreciated:

• US Treasuries are already trading on the basis that they are "AA" relative to German Bunds 

• Observable prices are going up; real estate at the high end, many food items, costs of services. (We don't fully appreciate the impact of the decline in energy prices.)
  
  

• The measures quoted by the various government agencies on inflation do not capture the hollowing out of middle class employment conditions. While there are a large number of highly skilled job openings, the costs of general employment are structurally rising and those positions that can not be replaced by machines are being supplanted by lower cost domestic and foreign contractors.

Society and investment policies do not reflect the changes and the long-term outlook.

Please share with me how your long term outlook is involving.

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Betting For or Against Nobel Prize Winners

Introduction

This past week we learned that Gene Fama, Lars Peter Hansen and Bob Shiller  received Nobel Prizes for Economic Sciences. These are relatively new awards starting in 1969 in honor of the founder of the Nobel awards, Alfred Nobel.

Nobel Prizes, except the questionable Peace Prize given by a different committee in Norway, are based on the discoveries and insights developed many years before the award. A relatively small number of the awards given for economics have had their focus on securities selection. There is no substantive record of whether they work in producing winning portfolio performance. A number of past winners became highly paid consultants to investment groups after the award. These have produced nice lunches and wonderful dinners, but little in the way of commercially exploitable performance.

What are the implications of these three awards?

Each recipient was trying to find a systematic way to invest profitably. They should have gone to the racetrack and listened to those in the Grandstand or perhaps better, in the higher priced Clubhouse. After each race people talk about why in the next race their particular choice will win. If someone has a number of winners in succession or at least a preponderance of winners, he or she has a “system.” Having been exposed to these various systems whether they have been mathematically based or dependent upon anecdotal information about the horse, its breeding, its trainer, its jockey, the jockey’s agent, the condition of the track or the colors of either the horse or what the jockey is wearing, I can attest to the fact that none of them work a majority of the time. The key to making intelligent bets at the track and in the market is to be sensitive to changes from the past. Otherwise one can be like some generals/admirals in the Pentagon fighting the last war brilliantly; for after the war they have determined what may have caused the victory or defeat.

Is there is a message in the Nobel Prizes?

By awarding three learned economists this year’s prize where each had a different point of view, methodology, or to use the racetrack term a system, the committee may be saying that there is no uniform selection process that works all the time. This is not to say that their work is worthless. Gene Fama was one of the founders of Dimensional Fund Advisors (DFA) which manages a number of mutual funds, some of which we use for clients. The practitioners have focused their money using other selection and perhaps more importantly, trading techniques. The result is a relatively low cost (not as low as pure index funds) portfolio of a large number of securities which allows them to nibble at bargains when offered. Sometimes they will have above average results and some times not.  As the inventor of segmented performance by quintiles, I can’t remember seeing their performance in the top or bottom one fifth of an array.

The Shiller approach, looking at the last ten years earnings relative to current prices, is a useful beginning to analysis. The analyst in me rejects sole reliance on reported results. I believe that one must first adjust the results for changes in tax rates, mix of business and tactical opportunities, accounting changes, changes in shares outstanding and significant changes of management. While I urge client expectations to focus on performance of at least the last ten years, I do adjust my thinking to recognize cyclical developments.

All of these approaches are useful until they become too popular.  They are not the complete answers to successful investing. In part because the favored investment styles of the economists  (small, value, momentum, and quality) will be redefined by market forces and in all likelihood smart-eyed observers may find other winning groups based on management techniques, technological supply chains, beneficiaries of social media, etc.

Changing conditions

One of the problems when intensely looking at present conditions is that something that appears to portend broader changes may not be very important in the future, and other incidental observations could be the recognition of bigger things to come. Two items caught my eye this weekend. I offer them up for our subscribers to consider or reject in terms of implications and importance.

The first item is that hedge funds reportedly have their biggest short position in gold since January. This may be a sideshow and only important to “gold bugs” or it could be a clue of how some hedge funds are looking to play catch-up from being behind the larger market advances. Undoubtedly at some point various markets will decline, perhaps meaningfully. The risk that all short sellers take is if the items that they are short move up dramatically, they may be forced to buy back the shorted securities at a rapidly advancing price. In other words they could be caught in a short squeeze, particularly those who shorted gold. With announced trading volume quite light, a squeeze could be applied.

The second item is that yields on German Bunds are closing in on the yields on US Treasury Bonds. For some time, global investors have felt more secure with the credit value of the German government paper than that of the US. Thus they were more expensive in price with lower yields. The closing of the yield spread could indicate that global investors are less worried about the credit value of US government paper which could be good for the US stock market from a foreigner’s point of view. At the very same time foreign currencies are appreciating against the dollar. Part of this may well be caused by an increase of US investments into Europe and possibly Japan.

Would you please let me know what you think?

_____________________________

Did you miss Mike Lipper’s Blog last week?  Click here to read.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com .

Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.