Introduction
The
very positive attributes attached to an activity frequently also carries some
additional negative attributes. Often the investment marketing armies sing the
praises of individual stocks and equity mutual funds due to their near-instant
liquidity. In the US, one can get out of the market 252 trading days a year.
What the proponents don't mention is the temptation to react to news and/or
change in sentiments and over-trade a long-term investment account. While there
are some managers that have great trading skills, the few that have these
skills can make more money for themselves and possibly their investors in hedge
funds. Generally I find that the most successful managers of long-term oriented
equity funds have a portfolio turnover rate that is less than the average. As
bad or unexpected things do happen to companies and markets, some occasional
pruning is often necessary otherwise they will mirror passive portfolios or
ETFs which can be a painful experience in a major market decline.
Each
day if not each hour, a holder of equity securities is bombarded with new
information, including some of which is accurate. The job of a wise, experienced
manager is to identify what incremental bit of information is of such potential
magnitude that it should cause a portfolio change. The risks of premature or
basically wrong decisions are not just what it does to the investment account.
The biggest penalty is a human failing to quickly recognize a mistake and buy
back the investment just sold or in some cases buy more. This past week it was
widely reported that Carl Icahn was interested in selling some or all of his
large position in a particular stock. The rumor drove the stock lower, so much
lower that Mr. Icahn bought more rather than selling. While some may feel that
his actions were manipulating the market, I believe he demonstrated one of the
attributes that has made him successful. He has identified both a sales price
and a buy price and will move appropriately whatever the market serves up. Most
managers do not act as dynamically and I am not sure that I want to see much of
this type of activity in mutual funds that we invest.
The
Current Situation
Perhaps
it is just the summer doldrums or waiting for the Fed to raise short-term interest
rates, or until various political decisions become clear. Regardless, there are
very narrow price changes. Thus significantly below-average volatility is being
experienced. Some may call it complacency. I think it is more petrified.
Petrified of zigging when we should be zagging.
To
me there are more positive elements present than negative, but I
recognize that the lack of stabilizing capital can lead to significant
declines. This last week through Thursday, (prior to the somewhat inconclusive
Jackson Hole speech by the Chairman of the Federal Reserve) could show the
tendency to accentuate the negative.
The
best sample of inputs that I look at is the performance of mutual funds broken
into various investment objective categories. My old firm, Lipper Inc,
now a part of ThomsonReuters, publishes the weekly performance of 96 separate
mutual fund peer groups. In the week through August 25th, there was only one
investment objective that gained more than 1%, the Dedicated Short Biased funds
+1.40%. On the other hand there were 16 separate categories showing declines of
over 1%. This list was led by the Precious Metals investment objective -10.29%,
followed by 4 different commodities categories off by 2 and 3%, 3 energy related
peer groups, 2 Health/Biotech fund types, and 2 Latin American and Emerging
Market Equity funds. The breadth of the list of declines demonstrates the
unforgiving nature of the market that
seems like a neighborhood of one-way streets.
In
the short-run, the positive offset to a somewhat punishing market decline is a
signal that the bond market is flashing for stocks. Barron's Best bond yields
dropped to 2.86% from 2.93% in the prior week and 3.81% a year ago. Barron's
has found that as yields rise and therefore bond prices decline, that within
the foreseeable future stock prices will rise.
The
Longer Term Picture
My
primary responsibility is to invest for institutions and a few families for the
long-term. The shortest judgment period for account owners is in the
Replenishment Portfolio of our TIMESPAN L Portfolios® which is
normally five years.
I assume over most five year periods there will be at
least one year with a decline of about 20%. I am reasonably confident currently that we
can meet the obligations to replenish the expended operational funding,
normally about two years’ payments. My confidence is based on the very same
fund data source that was used above to focus on last week's performance. In
the Lipper,
Inc. report, the average gain for US Diversified Equity Funds for the
last five years was +8.79%. In some cases it could be wise to leaven the cake
for stability or to address specific opportunities by dipping into the
following categories: BBB bonds 5.39%, High Yield bonds +5.35%, Mixed Asset
funds +5.35%, Sector funds +4.45% and World Equity funds +2.54%. Using funds
out of the last two categories could be worthwhile at times particularly for
longer term timespans in terms of the World Equity funds and shorter timespans
for the Sector funds. Currently I am noticing Small Cap funds’ performance is
accelerating both in the US and Europe.
Others,
including Charles Schwab & Co. believe that the market has further to run.
I concur primarily because in the equity world I don't see massive speculation,
yet. However, I am concerned by both the level of leveraged speculation in
various government bond markets led by the US, and by the growth of non-bank
credit sources.
On
a secular basis one can see a number of possible trends that will be coming
over the horizon that can be bullish for the equity investor wishing to meet
future desired funding needs. Not all of these will work out and each is not
without controversy, but each has the germs of a great force:
1. Instead of the politicians focusing on
employment votes, they could shift to the larger consumer vote found in Walmart
and other places. This can lead to a much reduced level of tariffs and
non-tariff trade barriers. The key to this happening is to find suitable
employment for the low-skilled which could be in extended healthcare and
infrastructure needs.
2. An aging population leading to less malls and
more delivery services.
3. Less reliance on government and central banks
as decision-makers and more reliance on market forces with profit-oriented
multinationals leading.
4. New leadership in government, business, and
non-profit sectors that are
better equipped to manage than the current seat-warmers.
5. Corporations reducing or perhaps eliminating
regular repurchase programs being replaced with longer term payoff capital
expenditures.
6. The global recognition of the need to reduce government
in Europe, Asia and North America.
In
Conclusion
I
would not wait for the eventual dips to get to the proper balancing of your
accounts. At this point, for long-term
accounts, the penalty of missing today’s price opportunities will seem small
when viewed from the completion of your long-term funding desires.
Publishing
Note
Due
to the Labor Day holiday in the US, next week’s blog will be published Monday evening,
September 5.
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A.
Michael Lipper, C.F.A.,
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