Introduction
There are no perfect
rules about investing. Everything we think we know should carry with it a
notation of a margin of error.
One of the advantages
that I had growing up was to learn that one could have a winning day at the
thoroughbred race track by cashing tickets only on one third of the races; in
other words by picking one’s bets carefully and knowing when not to bet. The
big advantage, in theory, that individual investors have over most fund managers
is that individuals can be like me and not bet every race because of a lack of
conviction as to its outcome or that the odds did not have an appropriate
risk/reward ratio imbedded in the bet. My long-term analysis of the historical
records of investors who stay in the game is that they are right on the order
of 50% of the time and if they wind up by having more of their money on winning
positions, can come away a monetary winner being right only 40% of the time. I
believe most fund managers that have long-term records of ten or more years are
right around 60% of individual quarters and years. The great ones are right
perhaps two-thirds of the time. With all
that as a statistical prelude to indicate that being wrong is part of the game,
I turn my attention to the remarkable first week of January trading. US stock
prices were up roughly 5% in the four trading day week. One of the favorite
market tales is that there is a “January Effect” which states that as January
prices go, so goes the year. The believers in this theory are encouraged by the
first day’s trading and the first week’s as well. Historically the “January
Effect” does work, as do most months in most years. (The US market goes up over
time most of the time.) There is some reasoning behind the belief in the
“January Effect.” In early January many pension funds, 401(k) and similar plans
get their money destined for the equity market and therefore they are buyers.
Despite all the dour headlines and pundits’ chatter, the first week is actually
a continuation of the halting rise in market prices that was evident in the
fourth quarter of 2012. Nevertheless, the purpose of this post is not to jump
on the momentum train, knowing full well about error rates and that optimism is
contagious and often leads to unfulfilled results. The purpose of this week’s
blog is to understand the dichotomy between the rising market prices and the
very subdued comments of well-known and somewhat learned economists and
investment strategists.
The
focus of economists and analysts
1. The
recent tax bill is being celebrated by the media as saving the country from
entering another recession. (My personal point of view is that it will hurt the
economy long-term.) The tax bill did not address the causes for the deficit and
actually added to the deficit. The real losers from this bill will be the lower
and middle level income tax payers as well as those who pay no income taxes.
All of them will suffer from an increase in the rate of inflation as capital
owners will attempt to offset the increase in their tax costs through raising
prices and slowing any hiring plans, particularly to reduce the impact of Obamacare
on their income. What is probably the worst thing about the tax bill is a
continuation (along with the central banks of the world) in attempts to manipulate
the economy. After a generational expansion of the US economy, we need to materially
improve the management of our own spending as well as to maximize our productivity. From time immemorial we have had economic cycles.
Attempts to delay the cycle have often led eventually to a much worse result.)
2. The
tax bill included a number of benefits to particular special interest groups.
This was evidently needed politically to get enough support or was a “due bill”
to be paid. Mohamed A. El-Erian in his latest piece points out that politics
drive economics in Italy, Japan, and the United States whereas in China, Egypt,
Germany, and Greece economics drive politics. (I believe the second group are
much closer to dealing with their structural problems than the first group.
3. The
US Federal Reserve, the Departments of Labor and Commerce, as well as the SEC
have publically admitted that they do not have the correct statistical tools to
fully understand what is happening within their specific areas of regulation.
If they don’t have the right tools one has to fear their regulatory policies and
recognize that it will be unlikely that the Congress or the White House can
come up with appropriate policies.
4. Some
economists are pessimistic as to the long-term growth for the US. They cite the
record levels of operating margins and expect less in the way of major economic
benefits from innovation. (Ironically Professor Krugman believes that some are
underestimating the growth potential from wider adoption of robotics.)
5. Analysts
have significantly lowered their current estimates of soon to be released 4th
quarter 2012 earnings, with particularly lower estimates for tech and financial
companies.
6. The
expected growth within the US of electricity use is expected to be below 1%
even with all the new electronic gadgets in-use. This is important for two
reasons. First, if the electric utilities cannot grow their bottom lines they
will be unable to directly pay for either major upgrades to their transmission
grid systems or the new energy sources that the government is pushing. If these
new expenses are to be mandated, either utility rates will have to rise and/or
the government will have to subsidize these efforts. Neither will help the
consumers or a struggling economy. The second reason is that slow growth in the
US use of electricity is an issue for those of us who are concerned about the
growth in China. One of the departing leaders from the top group of government
officials publicly indicated that he felt the quality of the data for their own
GDP calculation was “soft.” He preferred to use data on electricity usage and
bank loans as more accurate indicators of their growth. If the Chinese
eventually follow our pattern, their growth in the use of electricity per
person will decline which may possibly hurt our ability to understand what is
happening in what will be a major market for our goods, services and capital.
What
do these market prices indicate?
1. The
first week’s surge, which cannot continue for long, may have had three unusual
inputs. First, those with too much cash un-invested felt they had to get in, for
the realization of the impact of the tax bill was turning their cash into
trash. Second, those who had large accumulated losses without much near-term
hope of getting even wanted to recognize their higher tax value losses. Third,
US investors wanted to protect the dollar value of their portfolio by moving
some of their money into multinational stocks.
2. Lipper,
Inc., now a part of Thomson Reuters has international, global, and largely
domestic mutual fund categories for the various types of funds. On average the
international funds performed better than the global funds which in term did
better than the domestic oriented funds. Most of the superior results, particularly
in the fourth quarter, were due to translation gains. The foreign currencies,
euro, yen and pound, rose relative to the US dollar or if you prefer the dollar
declined relative to its investment competitors, just as the Fed wanted.
3. The
yield spread between high yield bonds relative to treasuries of similar
maturities is the narrowest on record, below 6%. The owners of these “junk
bonds” are betting on an economic recovery with a relatively low default rate.
As some of the buyers of this paper are essentially “yield hogs” rather than
sophisticated analysts, this may be a danger signal. One indicator that I have
quoted before may show the growing confidence in taking risk. The Barron’s Confidence Index published each
week is a comparison of the yields of higher-quality bonds to mid-quality
bonds. The index typically moves about 1% point a week, This week it rose 2 percentage points which normally is
favorable for taking risks in stocks and therefore "junk bonds."
4. The
movements of the stocks of financial services companies are important to me for
two reasons. First, in our global economy we transmit our wishes through
financial channels; so the health of those channels is important. Second, as
most of the readers know, I manage a private financial services fund along with
much larger portfolios of mutual funds that I also manage. As mentioned above,
some analysts significantly lowered their 4th quarter earnings
estimates for the financial stocks. The prices of these shares have been rising
and particularly in the first week of the year. I believe one of the reasons for
their gains is that the committee proclaiming the Basel III agreement has
wisely become more flexible as to what is to be considered good capital for banks’
liquidity reserves and delayed its full implementation to 2019. (I suspect
moving away from a reserve made up of sovereign bonds was viewed as slightly
risky compared to a collection of high quality securities including some
mortgages and even equity.)
5. The
markets reacted strongly to the publication of the latest Fed meeting minutes,
where for the first time in the minutes (but not the first time in individual
governor's speeches), there was concern expressed by some with the continuation
of their various “quantitative easing” policies expanding their balance sheet.
Possibly we won’t see their attempts to manipulate interest rates forever. As
already mentioned, the Fed recognizes it may not possess the right tools to
understand the economy. (I am wondering if in the future our “normal” level of
unemployment will not be deemed to be closer to 7% with lower rates touching
off higher inflation fears.) Further, I suspect that in examining the labor
force participation one should look at six sub groups: employees at small,
medium and large enterprises plus federal government workers, state and
municipal workers excluding teachers. I would suggest that each
of these groups have different needs and impacts on both our economy and more
importantly our society.
6. Later
this coming week my good friend Byron Wien will formally present his thinking
about the surprises he expects for 2013. One of the reasons that I like Byron
is that he has a strong streak of a contrarian in him, as many survivors do. He
has a good batting average on being right on his surprises. As a contrarian
myself, I hope that this year he will not do as well as usual, as many of his pre-published
‘surprises’ are already uncomfortable to me.
Please share with me
how 2013 looks to you.
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