By A. Michael Lipper, CFA
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 we are to 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 nearby “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 (NASDAQ:AAPL)* stock and we buy these products through the Verizon (NYSE:VZ) 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. I expect that we will 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 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 in terms of 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 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 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 and have 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 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 the T. Rowe Price* New Horizons fund, which 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 United Kingdom’s Daily Telegraph. In this era of 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, 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. Second, to a market observer the Moody’s announcement is not a surprise, as the markets for both 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 — a cousin who also has a locally obtained master’s degree. She was confused as to how the U.S. 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-chair), 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 he is 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 different time horizons. I am, for the most part, reserving my buy recommendations for stocks that appear to have substantially more long-term upside than short-term downside.
My sell recommendations are largely driven by cash funding needs, rebalancing within agreed-to guidelines, and in anticipation of some current holdings that are enjoying upward momentum but that have a history of significant drops when the markets turn nasty (as they always do). For long-term 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.
Please share your thoughts with me on these topics.
*Disclosure: Either owned personally or owned by my private financial services fund.
Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.