Tag Archives: author

Investors Are Finally Putting Their Cash To Work, Primarily Into 2 Categories Of Assets

The title of my previous posting was “investors have been selling but haven’t yet decided what to buy.” I had studied published fund flows and discovered that money had mostly gone out of equity and corporate bond funds into money market funds and bank accounts, but very little of that money had been shifted into other assets. I speculated that, as is typical in the early stages of any U.S. equity bear market, investors were nervous about a global stock-market decline, so their first reaction was to sell without buying anything with the money. I concluded that this decision not to buy anything was temporary, and that they would soon decide to make purchases which would mostly end up surprising many analysts. During the past few weeks, investors have indeed been making clear decisions about what they most wanted to accumulate. These decisions have primarily benefited two major kinds of risk assets. It is worth examining how this will affect the financial markets going forward. Only a relatively small percentage of this money which had come out of U.S. equity funds has gone back into the previous favorites, which includes funds based upon the Dow Jones Industrial Average, the S&P 500, the Nasdaq, the Russell 2000, and similar index-based choices. Investors are progressively concluding that the best-known best-known benchmark U.S. equity indices are unlikely to keep making new all-time highs as they had routinely done in 2013-2014 and during the first several months of 2015. This is significant, because it probably means that we have transitioned from a bull market which lasted for roughly 6-1/4 years to a bear market which could persist for roughly another two years. It is also noteworthy that investors haven’t just kept their money in cash, not just because cash pays almost zero interest, but because the overall percentage declines in their overall net worth have been modest. Investors tend to pile into cash when losses have been so dramatic that they are concerned more about additional red ink than they are about making money or anything else. Investors’ tend to usually be obsessed with not missing out on rallies for the latest hot assets. Since their respective bottoms primarily in the late summer and early autumn of 2015, there have been two primary groups of outperforming securities: 1) the most popular individual names which have been soaring in recent weeks amidst widespread glowing media coverage; and 2) especially oversold and undervalued assets, some of which had suffered bear markets for several years. The second category includes most shares of commodity producers and emerging markets which mostly began their respective bear markets in April 2011 and which had generally suffered substantial losses of more than half and in some cases of more than three fourths. Let us consider each of these kinds of decisions. It is easy to see why investors would embrace the latest trendy names on Wall Street. With Oprah Winfrey buying a much-publicized stake in Weight Watchers (NYSE: WTW ), who could resist such a celebrity-laden endorsement? Similarly upbeat media coverage has also boosted the shares of stocks including Amazon (NASDAQ: AMZN ), Facebook (NASDAQ: FB ), and Google (NASDAQ: GOOG ). The kinds of investors who have been buying these shares are generally amateurs who watch cable TV and browse the internet periodically, and are especially attracted to stocks which have easily remembered stories and are familiar to them in their daily lives. Whenever a bull market is transitioning to a bear market, there will be fewer and fewer winners, so more and more people will want to own whatever is going up. There is a second group of securities which is much less widely known and which so far has continued to receive mostly gloomy media coverage and negative analysts’ commentary. This includes the shares of nearly all commodity-related assets, including commodity producers and emerging-market shares. Since these achieved their respective multi-year and multi-decade bottoms primarily during the summer and early autumn of 2015, they have been among the most notable outperformers especially in subsectors including gold and silver mining which have been the biggest percentage winners during the past several weeks. Besides being much less well known than the securities listed in the previous paragraph, these have been far more popular with insiders and institutions rather than with individual investors. From a fundamental point of view, the big-name stocks listed in the previous paragraph are probably significantly overvalued and sport unusually high price-earnings ratios in the cases where they are actually making money. In sharp contrast, most commodity-related and emerging-market assets have especially low historic price-earnings ratios and are mostly trading far below their respective fair-value levels. These are compelling bargains in both absolute and relative terms. As more time passes, I believe that most of the widely popular favorites will tend to fade as they usually do as a bear market experiences a natural state of maturing. On the other hand, since they had become so unpopular, even a reduction in the gloomy tone of the media and analysts’ commentary could be accompanied by substantial percentage gains for commodity-related and emerging-market assets. Since most of these have slumped so dramatically during their extended bear markets, many of them could double and even triple while still remaining far below their peaks of recent years. For example, the First Trust ISE-Revere Natural Gas Index ETF ( FCG), a fund of natural gas producers, had plummeted by more than three fourths from its June 2014 top to its September 29, 2015 bottom of 5.43. If it merely regains half its June 2014 high then those who bought it near the bottom will end up doubling their money on those purchases which were made close to the nadir. Another example is the Market Vectors Gold Miners ETF ( GDX), which had slumped by roughly 80% to its September 11, 2015 nadir of 12.62 and has since been among the biggest winners of all exchange-traded funds. Funds of junior producers such as the Market Vectors Junior Gold Miners ETF ( GDXJ) had suffered even greater percentage declines and could thus be especially impressive in the intensity of their rebounds. Gains of hundreds of percent are possible without new highs having to be achieved. Similarly outsized percentage increases could be the most likely scenario for many subsectors related to mining and energy. If this were a horse race, these should be favorites but instead carry the odds of long-shot dark horses. It is noteworthy that the kinds of behavior which typified the bear markets for commodity producers and emerging markets have been much less prevalent in recent weeks. Early intraday lows tend to be followed more frequently by rebound attempts. Many of these shares have formed several higher lows in recent weeks. Insiders had mostly been significant buyers near all low points during the past several months, while fund outflows had reached all-time record extremes for many subsectors. Most analysts and brokerages have continued to reiterate the downside targets for these generally unpopular assets, so that hasn’t yet been transformed into progressively more bullish commentary which will likely begin to occur more frequently in the near future. Since many of these securities have been among the biggest percentage winners in recent weeks, they are slowly attracting the attention of momentum players and other groups of potential buyers. Some of their purchases have been especially untimely, tending to occur following recent extended short-term strength which usually leads to a rapid short-term correction in order to shake out the sell stops which so many of these kinds of traders tend to employ. We saw such a rapid correction especially on Friday, October 16 and Monday, October 19, 2015, and there will likely be more of them whenever people have become too optimistic toward their short-term behavior. Eventually, I expect to see amateurs following insiders and institutions in becoming buyers, since they will observe that many of these assets have doubled, tripled, or better, and will hate to miss out completely on such strong rallies. As is usually the case during any bull market, the earliest buyers tend to be insiders and deep value accumulators. This tends to be followed by a wide range of buyers at each step on the way up, until finally amateurs are eagerly participating while insiders begin selling. I think that we are probably a very long way from having to be concerned that these rallies are over or nearly so–especially since so much of the commentary on the internet in recent days has suggested that these rebounds are finished and that these assets should be sold short. A rally for anything doesn’t end with most people believing that new historic lows lie shortly ahead, but when almost everyone is asking themselves how much higher it is likely to go and how long it will take for various upside targets to be surpassed. Disclosure: In August-September 2013, and at various points during 2014-2015, I have been buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares–and more recently energy shares–especially following their most extended pullbacks. I have also been accumulating HDGE whenever U.S. equity indices are near their peaks; HDGE is an actively-managed fund that sells short U.S. equities. I believe that U.S. assets of almost all kinds have become dangerously overvalued. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, HDGE, COPX, GDX, EWZ, RSX, REMX, GLDX, URA, FCG, IDX, GXG, VGPMX, ECH, VNM, BGEIX, NGE, RSXJ, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position to roughly 3% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I also sold all of my FCG when insiders were unloading, but I repurchased FCG in recent months following its collapse of more than three fourths of its June 2014 peak because there had been intense buying by top corporate insiders of companies which produce natural gas. I expect the S&P 500 to eventually lose about two thirds of its May 2015 peak valuation, with its next bear-market bottom occurring within several months of October 2017. The Russell 2000 Index and its funds including IWM had only modestly surpassed their highs from the first week of March 2014, while the Russell Microcap Index (NYSEARCA: IWC ) marginally surpassed its zenith from March 6, 2014. The S&P 500 Index set a new all-time high on numerous occasions during the same period, and may have completed its final top for the cycle at 2134.72 on May 20, 2015. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have “forgotten” or never learned the lessons of previous bear markets are doomed to repeat their mistakes.

Singer Meghan Trainor Knows, It’s All About That Central Bank Stimulus

Just how powerful is the combination of quantitative easing (QE), zero percent rate policy and even negative percent rate policy? Omnipotent. With the recent revelation from the ECB, and the predictable reaction of market participants, is it time to amplify your risk taking? Quite possibly. On the other hand, there are at least two reasons to exercise some restraint. Nearly one-third of S&P 500 corporations have reported earnings and revenue from the third quarter. With 147 companies chiming in, profits are down -0.6% and sales are down -2.7% from a year earlier. One might have thought that several quarters of contraction in earnings and revenue (a.k.a. an “earnings recession” and a “revenue recession”) might have weakened stocks. After all, if robust sales and hearty profits are the primary drivers behind price appreciation for companies in the Dow and the S&P 500, shouldn’t diminishing sales and dwindling profits lead to price drops for the Dow and S&P 500? Welcome to the mixed-up world of centralized bank planning. For example, at a news conference today (10/22/2015), the president of the European Central Bank (ECB) underscored the downside risks to the euro-zone economy. Mario Draghi emphasized everything from the impact of China’s slowdown to the rapid-fire fall in commodity demand. His prescription? More central bank stimulus up-and-above the ECB’s existing bond-buying program and negative interest rate policy. On the news, developed world benchmarks (e.g., Dow, S&P 500, Stoxx Europe 600) surged by more than 1% across the board. Did it matter that Caterpillar (NYSE: CAT ) discussed its expectation for 2016 revenue to collapse by 5% across all of its segments (i.e., transportation, construction, resources)? Nope. Did investors fret 3M’s (NYSE: MMM ) intention to reduce its global workforce by 1500 positions on dismal earnings? Hardly. Investors have come to expect huge rewards for taking risk when central planners engage in extraordinary levels of borrowing cost manipulation. Perhaps ironically, weakness in multinational earnings and revenue simply confirms weakness in the global economy. Indeed, the weaker the results, the greater the likelihood that the ECB will step up its stimulus measures and the greater the probability that the U.S. Federal Reserve will leave 0% lending rates intact. Bad news is good news yet again. Just how powerful is the combination of quantitative easing (QE), zero percent rate policy and even negative percent rate policy? Omnipotent. Take a look at the performance of the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) as it relates to the creation of electronic dollar credits for the purpose of buying debt, or QE. Specifically, in mid-December of 2012, the U.S. Federal Reserve upped its QE3 program to $85 billion per month in the acquisition of U.S. treasuries and mortgage-backed securities. The program began winding down in 2014 during the “Great Taper,” though the final day of the last asset purchase actually occurred in mid-December of 2014. The 2-year performance for VTI? Approximately 52%. Now take a look what happened from the removal of the stimulus “punch bowl” through October 21st of this year. The gains have been so paltry, an all-cash position provided a better risk-adjusted return. With the recent revelation from the ECB, and the predictable reaction of market participants, is it time to amplify your risk taking? Quite possibly. On the other hand, there are at least two reasons to exercise some restraint. First, extreme stock valuations challenge the notion that you should always follow the central banks (e.g., Federal Reserve, European Central Bank, Bank of Japan, Bank of England, etc.). Warren Buffett’s favorite measure of stock valuation, total-market-cap-to-GDP, sits at 117.7%. That is the second highest in history and it is higher than the 2007 peak of 110.7%. Market-cap-to-GDP fell to 62.2% at the 2009 March bottom. In addition to clear concerns regarding fundamental valuation, the most widely regarded technical indicator still points to a long-term downtrend. The S&P 500 has yet to reclaim its 200-day moving average since falling below the level in mid-August. (Note: That might change by the time this article hits the Internet!) Prior to the start of the mid-August correction, our tactical asset allocation moved moderate clients from a 65%-70% equity stake (e.g., domestic, foreign, large, small, etc.) to a 50%-55% equity stake (mostly large-cap domestic). Similarly, we shifted the 30%-35% income allocation (e.g., short, long, investment grade, higher yielding, etc.) to something akin to 20%-25% income (mostly investment grade). The aim? Reduce exposure to riskier assets and raise cash equivalents to roughly 25% for a future move back into risk assets. Granted, valuations represent a significant concern over the longer-term . This bull market in stocks is unlikely to carry on indefinitely regardless of central bank rate manipulation and monetary stimulus. That said, trendlines and other market internals give us the best indication of near-term risk preferences. It follows that a break above 200-day trendline resistance coupled by continued improvement in credit spreads and advance-decline lines would be a reason to put some capital back to work. Where might I add some risk? At present, our equity holdings include funds like the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). Certain sector funds that have already reestablished respective uptrends – The Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the Vanguard REIT Index ETF (NYSEARCA: VNQ ) – are funds on my radar screen. By the same token, investors may wish to hedge against a longer-term bearish turn of events. The ECB’s comments this morning did not just create demand for “risk-on” assets; that is, “risk-off” assets are holding their own. German bunds catapulted higher on Draghi’s comments. The U.S. dollar via the PowerShares DB USD Bullish ETF (NYSEARCA: UUP ) skyrocketed. And risk-off treasuries at the long-end of the curve also gained ground. In fact, a second-half-of-the-year comparison between the FTSE Multi-Asset Stock Hedge Index (a.k.a. “MASH”) and the S&P 500 shows the value of multi-asset stock hedging. Components of “MASH” include zero-coupons, TIPS, munis, long-dated treasury bonds, gold, German bunds, Japanese government bonds, the yen, the dollar and the Swiss franc. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

How Valeant Revealed The Dirty Little Secret Of Fund Management

How would you feel if your equity fund manager lagged the index by 5% in a year? Supposing that you hired the manager, or bought his fund, as part of the diversified equity portion of your portfolio and he missed by 5% in a year. Let’s say that you be patient, then he underperforms by another 5% in the next six months. Would you fire someone who lags the market by 10% in 18 months? Returns vs. business risk I have met people who say that they love managers who hit the home run and loathe benchmark huggers, but investors get very nervous when their managers lag the market by as little as 5-10% in a relatively short (1-3 years) time frame. From the perspective of the manager, this level of risk tolerance brings up the issue of business risk. How do you maximize performance using your process, or “secret sauce”, without taking on excessive business risk that sinks the entire firm? Risk comes in all shapes and sizes. For an equity portfolio, common sources of risk are sector and industry risk, market cap risk and stock specific risk. To illustrate my example, consider the lowly issue of stock specific risk, which should be diversifiable (at least according to theory). The recent case of price volatility in Valeant Pharmaceuticals (NYSE: VRX ) is an instructive example in risk control. In the past few weeks, I have spoken to a number of Canadian portfolio managers whose performance was blindsided by specific risk from that one single stock, The outlook for VRX is highly divisive and talking about it is the equivalent of bringing up touchy topics like religion or gun control in polite company. (Incidentally, I have no opinion on the stock.) The chart below depicts the price of VRX in the top panel and the TSX-VRX ratio in the bottom panel, which shows what would have happened to relative performance had a manager had no position in VRX for the past few years. Despite the fact that the stock got hit today, VRX has shown remarkable returns in the past few years. In the space of about 5 years, the stock has become a 10-bagger and anyone who didn’t own it would have underperformed the index (bottom panel). Consider the following effects for a manager who did not hold VRX: If he didn’t own it at the end of 2013, relative return shortfall would be over 8% when VRX hit its peak this year. For some investment organizations, that kind of shortfall could be a near-death experience. Even with the pullback, relative performance shortfall would only be back to 2013 levels and he have not made up for the shortfalls in the previous years. The art of business risk management The analysis brings up a key question for the business risk for investment management operations. Yes, we would all like to have the courage to bet our investment convictions, but how much business risk is the practice willing to take? Supposing that an operation were to lose half its clients because of a single decision on a stock, what does that do to the bottom line? Revenues would go down by about 50%, but there are fixed costs such as rent, salaries, systems, legals, etc. Profitability would plunge in such an instance, is the investment management business willing to take that kind of risk? If not, then there are a couple of steps a manager can do. First, he has to decide the appropriate level of stock specific risk he is willing to take against the benchmark. Supposing a stock has a 3.5% weight in the benchmark, would you hold a 0% if you ranked it a “sell” (-3.5% bet), a non-zero weight, such as 2.5% (+/- 1% vs, benchmark) or 1.5% (+/- 2% vs. benchmark)? On the other hand, if your ranked it a “buy”, would a 5.5% weight (+/- 2% vs. benchmark) be appropriate? What about 8.5% (+/- 5% vs. benchmark)? Another way of approaching the problem would be to try and determine the median competitor weight in the stock (with techniques that I have written about before). Then set benchmark weight to be the median competitor weight instead of the index weight. I show this example as just how a simple decision on a single stock can crash an entire investment management practice. I haven’t even gone into all the other ways that risk can rear its ugly head, such as macro factor, sector, size and so on. Asking too much of managers? This post also illustrates the dirty little secret of fund management. Investors are asking too much of managers and managers are consequently reacting rationally by closet indexing. Investors have to ask themselves: How much rope are you willing to give a manager to succeed? Is John Hussman flaming out, or is he a brilliant thinker going through a bad patch? Other well-known managers like Bill Miller and Ken Heebner have had their ups and downs, how patient are you willing to be? If you have a low level of patience, then you are forcing managers to become benchmark huggers because you are not giving them enough room to win. For managers: Given the realities of the market, how much risk are you willing to take so you don’t crash your firm? The opinions and any recommendations expressed in this blog are solely those of the author. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.