- DOWN 5% in the first 86 days of the second quarter!
- UP 4.6% in the final four days!
And most recently: Rising convincingly 4 days in July, then plunging just as convincingly the next 3 days, then roaring ahead yesterday based on some words spoken by the Chairman of the Federal Reserve, “full of sound and fury, signifying nothing”!
Is it any wonder individual investors are deserting the stock market? The shift from 75% individual / 25% “institutional” in the 1950s to 76% institutional / 24% individual today is more worrisome to me than any piece of news about the Euromess, China, or our own leader's inability to sit down and hammer out a simple compromise to the deficit reduction talks. (I call it “deficit reduction” rather than “lifting the debt ceiling” because the former implies actual action on the root cause of the problem, the latter merely political jockeying to see who takes the credit for kicking the increasingly heavy can down the road.)
It isn’t only that institutions are today the 800-pound greedy, boorish gorillas in the investing game. It is the type of institutions as well. As recently as the 1970s, “institutions” were comprised of bank trust departments, a few partner firms on Wall Street that guarded their capital well, a handful of mutual funds, and pension plans administered according to “prudent man” principles, most offering something as daring as maybe 60% blue chip stocks and 40% bonds.
In 1970, there were approximately 360 mutual funds with $48 billion in assets. Today, there are some 8000 mutual funds in the United States alone, with combined assets of more than $12 trillion – roughly the size of the US annual Gross National Product!
One mutual fund alone, the Vanguard 500 Index Fund, has more than $100 million in assets, double the number of every mutual fund in existence in 1970. John Bogle of Vanguard believes he has done the retail investor a favor by sponsoring index funds. That may be true – but he has also created the most liquid casino in the world and other institutions are the bettors who daily take the most advantage.
Add to this that “mutual funds” themselves have changed. We can now buy a 3x leveraged gamble on the market itself or on most sectors that comprise the markets. We can specialize, not just to the level of, say, technology, but specifically, the Internet; not just the Internet, but a small subset of the Internet. This creates – volatility. What’s an investor to do?
Now consider that the other “institutions” have radically changed, as well. When Wall Street partnerships began to go public, suddenly they were playing with Other People’s Money. And there was just so much of it. Why not swing a little?
Then bankers suddenly lost prestige and decided they needed some fun in their lives, too, so Sandy Weill bought himself (for only $100 million of Other People’s -- Citicorp’s shareholders’ – Money) the repeal of Glass-Steagall. Pension fund managers' bonuses became tied to performance, not capital preservation and reasonable growth, so they threw their lot in with the branksters, as well. (Brankster: my term for the brokers, bankers, and gangsters that now run Wall Street, banking and, more and more, the best politicians that money can buy.) So what's an investor to do?
Of course, this doesn’t even begin to describe the harm caused by the newest financial legerdemain, the hedge funds that take 20% of your profits in the good times and share in 0% of the losses in the bad times. Again, what’s an investor to do?
I’m glad you asked. I can’t speak for you, but here’s what we are doing for our clients in this crazy upside-down view of how money should be managed for value and growth:
Sadly, we have had to recognize that in a wild and wacky gorilla-dominated market where long term is close-of-market and no positions are carried over the weekend, buy-and-hold as we confirmed old Value Investors know and love it, is dead. I hate to write those words. Deep research, informed analysis and prudent acquisition of unpopular companies when their prices are cheap has been our stock-in-trade for nearly four decades.
Then, in 2007, as all these gorillas decided their minions needed not just penthouse apartment in Manhattan, a McMansion in the Hamptons and a Bentley to get them to and fro, but a helicopter to avoid the hoi polloi on the streets below, took ever-increasing risks with Other People’s Money (read: yours, if you own a mutual fund, have a pension plan, leave money in your margin account, etc.) The result was the gorilla-induced fiasco of 2008-2009.
The market rebounded, of course, but most investors did not. We Value Investors clung to the idea that securities selected for their quality, value and future growth prospects would still do well. They have not. What the gorillas need are 30,000 tons of bananas (apologies to Harry Chapin.) They don’t care about value. They care only about two things: price and liquidity. Because of this, we have had to think more defensively – short term ETFs and bond funds like PIMCO Enhanced Short Maturity Strategy ETF (MINT), Vanguard Short-Term Bond ETF (BSV), iShares Barclay's 1-3 Year Treasury Bond ETF (SHY), Eaton Vance Limited Duration Income Fund (EVV) and BlackRock Limited Duration Income Trust (BLW); floating-rate bond funds like ING Prime Rate Trust (PPR), Eaton Vance Senior Income Trust (EVF), Invesco Van Kampen Dynamic Credit Opportunities Fund (VTA) and BlackRock Defined Opportunity Credit Trust (BHL); preferred funds like Nuveen Quality Preferred Income Fund (JTP), John Hancock Premium Dividend Fund (PDT) and John Hancock Preferred Income Fund III (HPS); and inverse hedges like ProShares Short Small Cap 600 ETF (SBB), ProShares Short Russell 2000 ETF (RWM), and ProShares Short Financials ETF (SEF). And we must think more short-term. That part really hurts.
We also use trailing stops far more frequently – and keep them closer to the current price – than we ever did before. This means we are occasionally whipsawed, but at least we don’t let losses ride.
Finally, we are actively seeking situations not liquid enough to attract the gorillas. Remember, if they smell a banana in your pocket, they believe it is theirs! If we keep our snacks small, they are uninterested. That means we are now buying more quality value firms in well-governed foreign markets that respect the rights of shareholders. Our buy-and-hold (dare we say it!) of Norway’s Seadrill (SDRL) or Australia’s Lynas Corp (LYSDY.PK) or Singapore’s Hyflux (HYFXY.PK) (all US symbols) are testament that, if we can fly beneath the radar, we can still find genuine value at a fair price.
Oh, and as for yesterday’s “great news” that sent the market up 151 points and which MarketWatch gushed in its headline as “Fed's Thinking Outside Box”, here’s what I read in the Chairman’s words:
We don’t know why what we’ve done isn’t working.
Even if all our predictions about unemployment, real inflation, housing and the economy have been dead wrong for three years, we believe next quarter our predictions will be accurate.
We’re going to try three Cool!! New!! Different!! things if our efforts don’t work out like we promised they would / promise they will.
He then said that Option One would be for the Fed to state more forcefully than ever before that they would not raise rates. Specifically he said, he would give more “explicit guidance” to keep rates low for “an extended period.” Wow. That should take care of everything. I guess we didn’t need to give $800 billion of American citizens’ money to Citicorp, Goldman, et al, after all. We didn’t need to print and then buy $600 billion more in US government paper. We just needed to give more “explicit guidance”!
Option Two would be QEIII. No, he didn’t use those words. He said the Fed would “increase the average maturity of our holdings.” Read: ‘Don’t let the $600 billion mature; roll the debt over to keep the velocity of money high.’ Also read: ‘Kick the can down the road one more quarter.’
Finally, Option Three: The Fed currently pays banks ¼ if 1% on reserves held by the Private Bank cleverly called the Fed. The final daring feat would be to lower that even more “thereby putting downward pressure on short-term rates more generally.” “More generally,” couldn’t we just do what any intelligent family does when times are tight, only on a national level. Do away with the hundreds of billions of annual special interest subsidies, effectively raising huge amounts of “taxes,” slash spending, and lower by half the regulatory burden on job-creating small businesses, along with half the bureaucrats needed to promulgate, interpret and prolong them?
Until we rein in reckless institutional trading and feckless politicians, I must, with regret, eschew buy-and-hold through these virulent, news-driven times and hew to the strategy, and the selections and others like them, I have suggested above.
Disclosure: We, and/or those clients for whom it is appropriate, are long MINT, SHY, PPR, VTA, BHL, PDT, JTP, HPS, SBB, RWM, SEF, SDRL, LYSDY and HYFXY. Gustatory delight or sure path to indigestion, we eat our own cooking. We advise you to do your own due diligence to see if you agree.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.
We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. We take our responsibility to proffer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.