Today we’re going to talk about dividends.
This is a very a popular topic right now and it’s heating up as more investors around the world search for places to pick up some yield. There won’t be much jargon today, I’m just going to tell you some stories about why I like stocks that pay dividends. But if you do want some nitty gritty strategy, I urge you to check out this article that I did last week for Seeking Alpha. It’s a good complement to today’s newsletter. In fact, the article was awarded one of their Editors’ Picks and it made it to the #1 most popular article on the whole site last week!
I’ve watched Seeking Alpha grow over the years and they’ve become one of the best financial websites on the internet with an intelligent, active community of readers. They get almost 5 million visits per month. So it’s kinda humbling to have some of our contributions featured so prominently over there. The fun thing about Seeking Alpha is that they have a revenue sharing program for their contributors now. If you submit an article of original content, they’ll give you a slice of the ad revenue. It works out to about $10 for every 1,000 views. So far we’ve made $321.14 on this one!
That’s pretty cool, buuut I’m not about to quit my day job. Honestly, I don’t know how all you writers and professional bloggers out there make it work.
The big reason that we don’t run ads on our site is because I hate websites plastered with ad banners. But we also don’t have any ads here because that kind of revenue doesn’t really move the needle enough for us to justify to make it worth our while. Our traffic has grown dramatically in 18 months, from just a few dozen readers and pageviews at launch to over 5,000 hits here in February.
This too humbles us beyond belief, but in the grand scheme of The Internet we are very small potatoes. But if our traffic someday increases tenfold, then my capitalistic soul is probably going to have to duke it out with my noble ideals. I’m sure that will be fun for all involved parties.
Traffic is traffic, but feedback is a lot more interesting. I get comments all the time from readers about the things that we write. Usually they’re friendly and complimentary. But I get hate mail too and that’s just part of having a public presence. It’s not really “hate” mail, it’s just angry mail from people that don’t agree with what I have to say. That’s cool! I like listening to perspectives that push back against my own. As for the friendly comments, they typically center on the same couple of things but not until this guy has someone summed basically all of it up in one succinct paragraph:
I just want you to know that I absolutely love your newsletter. I am a bit of a financial news junkie and am always perusing various sites searching for thought provoking information. The more info, the more confident I can feel with my informed decisions about my investments. But your newsletter is not only informative, it is entertaining, enjoyable to read and contrarian. All stuff I love.
-DK in Ohio
This, in a nutshell, is exactly what we’re trying to do here at The Draconian. Thanks for the wonderful comment, DK! I hope we’ve been useful and/or fun for the rest of you.
In the meantime, keep clicking on our Seeking Alpha article. Mrs. Draconian wants a steak dinner at Outback!
Phew. OK, that’s enough shameless self-promotion for the next couple of months.
Let’s get down to business.
Market Recap
Tuesday was the worst day in the market since August. Since August! Why? For what reason? There wasn’t any major news that came out, at least nothing thematically different than what we’ve been reading about in the last few months. It followed up with another equally bad day on Wednesday.
It’s like we’ve been writing about week after week. When the market feels like selling off, it sells off. It does it all at once and it does it on heavy volume. Remember, this is not a historically normal dynamic. I’ll admit that I don’t entirely understand it, but I know that this is a much more dangerous environment than it’s given credit for. There’s so much complacency out there. Investors don’t seem to want to be bothered with worry about difficult-to-understand risks.
Check out the LIBOR-OIS spread:
Calm down. LIBOR-OIS isn’t as bad as it sounds – it’s just the difference between LIBOR and the Fed Funds rate. LIBOR is a market rate and the Fed Funds rate is fixed by the central bank, so the difference between the two is a measure of how concerned the markets are about things. I think of it as a barometer for risk in the credit markets. It goes up when the credit markets get scared and down when they feel confident. This is one of my all time favorite indicators because it does a fantastic job at warning you when bad stuff is about to happen and it’s usually early enough to help you.
It’s still at reasonably low levels, but it’s been quietly trending up since December. This is not a red light, but the light is by no means green. At best: stale green light. You know those, right? They warrant looking both ways.
We’ll be watching this in the weeks to come as we try and get a sense of whether this correction is just a simple breather or indicative of increasing worry about the global economy.
And don’t forget to keep your eyes trained on Crude Oil:
You guys all know that $100+ crude was one of our predictions for 2011, but honestly, I didn’t think we’d see that until the summer. Brent Crude topped $110 and the scuttle is that WTIC is artificially low right now because of a temporary oversupply in Cushing, Oklahoma where all this oil flows through. Argue all you want about which crude oil price to quote and the reasons for why it’s moving higher. The only thing that matters is that higher oil prices means higher gas prices which means consumer spending slows down which becomes a cyclical headwind for the economy.
It seems like I write about this over and over again, but Crude Oil has a wonky relationship with the market. At lower levels, it correlates with the market — an improving economy means people are willing to drive and travel more. But at higher levels, it correlates inversely with the market. Beyond $85-90/barrel, the knock-on effects kick in and consumers scale back to mitigate the effects of higher gas prices. I can’t overstate the importance of understanding the dynamics of relationship.
In the meantime, let’s take a look at some things that warrant watching while we’re in the dip.
Love at first sight
I think I’ve told this story before but my first real job in this industry was at UBS PaineWebber. I interned with a couple of muni bond pros there and they showed me the ropes of retail finance. I got to use an empty corner office on the 30th floor of Century Park East and watched the sun rise every morning over a hazy downtown L.A.
I was hooked for life.
This was during the dot-com bubble and my first day of work was in March of 2000 — literally at the peak of the market. I was excited to have a cool job. But no single person at any point in history has ever been as excited about a single thing as Jim Cramer was about technology stocks. Back then, people took “Dow 36,000″ seriously. It was a new dawn. It was a gold rush.
Once I was hired and getting paid to follow this stuff every day, the market just went down and down and down. The gold rush was over. Jim Cramer was wrong. And this had a profound effect on my own psychology. My first professional experience in the market was not how much people could make as investors, but how much they could lose. Now you guys all know why I’m so messed up!
But it actually wasn’t so bad. In fact it was a good thing. In retrospect I’m not sure there was a better time or place to get started in this business. Framing every aspect of investing in terms of risk is hardwired into my psyche. I can’t not do it the way kids of the great depression couldn’t not pick a penny up off the sidewalk. The way polyester-suited bond guys from the 1970′s can’t not freak out about The Inflation.
The experience was a major lesson for a naive kid looking to survive in the business. Soon after that I would come to an even greater realization. In the years after the dot-com blowout we would have the accounting scandals. This was where some of the “Big 5″ accounting firms were revealed to have engaged in shady dealings, falsifying the financial positions of companies like Enron, Adelphia, and Global Crossing. The financial data that investors thought was audited and legit was nowhere near the truth.
This was huge. Huge.
It rocked me to my core.
As a student of accounting at UCLA, someone whose peers all dreamed about landing a job with a Big 5 Firm after graduation, I took it personally. These scandals were a violation of trust, another deep wound that would never heal.
Every quarter, every publicly traded company reports its financial results. And I have a really hard believing most of it. Sure reading a balance sheet and an income statement can be handy for this or that. If you have some investments to sell or have to manage a portfolio and need to plug something into your spreadsheets, it works. But this data is self-reported and it’s supposedly verified by auditors from Wall Street, a culture that has violated public trust so frequently and so egregiously the only rational response is laughter.
Sarbanes-Oxley was supposed to fix this, to repair our trust in what these big businesses tell us. And for a while, it did. But then came Lehman Brothers and the infamous Repo 105 stuff. We thought we knew where AIG stood, but the reality was a bigger nightmare than we ever might have fathomed — they had a AAA rating! Then there was the rampant fraud in the mortgage industry to say nothing of all the debt securities they backed. A lot of people mistakenly thought we were supposed to be protected from all this stuff and that we could take all this information from these companies at face value.
This time, my response was laughter. ”Now there’s the financial industry I remember.” In case you are wondering, Dodd-Frank isn’t going to save us either.
Before you write me off as a damaged-goods conspiracy theorist, know that it isn’t all bad. In fact, most of this data is actually pretty good and can be trusted. The overwhelming majority of companies are honest. But there does exist an alignment of incentives for CFO’s to goose shareholder value any way they can, so long as it’s within the letter of the law. (Don’t even get me started on FASB.)
Ultimately, one thing helped me make peace with the realities of this untrustworthy world. The things that companies tell me are fine, but what’s infinitely more important are the things that a company does. Actions really do speak louder than words.
It was a simple thing that brought me peace of mind… “show me the money.”
Brother, you got to yell that shit!
SHOW ME THE MONEY!!!
This was what got me excited about fundamental analysis once again. And how do publicly traded companies show you the money?
They pay you dividends.
Show! Me! The! Money!
Who’s your motherfucker, Jerry?
A company that pays significant dividends — especially companies that raise their dividends year after year — is signalling to you that their financial condition is strong. Their business is making money and they are generating enough cash flow to support those dividend payouts. If they feel confident that they’ll grow and generate more cash in the future, they’ll raise that dividend. Cash is King, remember?
Another thing about companies that show you real dividends is that their earnings have to be predictable and stable. Businesses that wildly swing from profits to losses can’t afford to reliably pay out dividends, or can’t without borrowing to finance them.
Dividends can also be a good leading indicator. When a company is sinking, the dividend is usually the first thing to go. This is why dividend cuts are such a huge deal and reviled by shareholders. When a company cuts its dividend it’s like a gigantic blinking red light that says “UH OH!” The cockroach theory applies. Watching a company cut its dividend is like seeing a cockroach crawl out of the wall and scuttle across the floor. It’s not a pretty sight, but what’s worse is knowing that where you see one cockroach there are many more lurking behind the wall.
Eew.
Remember when Citigroup famously slashed its dividend in early 2008? Their stock took a beating after that announcement but on that day you still could have sold out for $27 a share. Crazy. Now we know that they had a pretty serious cockroach infestation.
If you are going to adopt one hard and fast rule when it comes to dividends, it’s to buy these companies with the intention of holding them forever but to immediately divorce yourself from them if they ever cut that dividend. Yes, owning a portfolio of dividend stocks is a lot like a marriage; the true benefits accrue over the long haul and sometimes you need a little faith to get through the day-to-day movement of the market. But if a company fools around with that dividend, that cornerstone of trust in our relationship, I consider it an act of infidelity.
Respond with haste and decisiveness.
L.A. cinephiles know that Neil McCauley was a straight up bad ass. A sensitive bad ass, but few in the modern crime canon were as disciplined as he. And you know what Neil McCauley would say. He would say, “don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.”
Those are words of wisdom when it comes to designing and managing an investment portfolio. And they are doubly relevant when it comes to dividend stocks. If you feel the heat coming around the corner, if you see them monkeying with that dividend, then you sell ‘em and move on.
One last thing
Dividends have been out of fashion for a long time. Basically as long as I’ve been in the industry. In 1999 somebody called up Jim Cramer and asked him about Johnson & Johnson’s 4% dividend yield. He cackled maniacally and said put all of your money in Pets.com!!
*Maybe he didn’t actually say that, but whatever. The point is still the same: dividends haven’t been cool for a while. Now they are cool and now you understand why. Investors of all shapes and sizes around the world are starving for investments with good yields that they can count on.
It’s a new dawn!
Venture forth, grasshopper
OK. It’s entirely possible that after reading this article you are really fired up about dividend stocks. I will admit, I got a little fired up while writing this.
So maybe now you want to go read our Seeking Alpha article on a neat dividend strategy. But only phase two of that strategy is relevant now. The little market correction is now underway. So now just hang out in cash as the market runs its course and then go shopping. I like to do my buying on dips for tactical reasons, but if you are a long term investor, things like this don’t matter quite so much.
If you want to learn more about dividends you can read this old newsletter where we talked about the Six Things You Need To Know. We also showed you how to set up a sample screen to find some of these companies on your own.
It’s good stuff. Talk to your financial advisor about it. He probably likes dividends too and probably has some more good ideas about how to pick up some yield you can count on.
- Keep your eyes on Crude Oil. It’s at the point now where the higher it goes, the more it eats into consumer spending and acts as a bigger and bigger cyclical headwind. $3.50 gasoline was a big stretch a couple months ago but today it seems all but certain.
- Show me the money! When it comes to stocks as an investment, your rule of thumb is “Show me the money!” Companies show the you the money by paying you dividends and then raising them. Nothing sends a worse signal than a company cutting its dividend.
- We all owe Cameron Crowe a debt of gratitude for one of the greatest slogans of the 90′s. But if you are bored this weekend go back and watch Michael Mann’s “Heat“. It’s one of the two or three best guy movies (and L.A. movies) of all time. If you are a true film lover, the scene with Pacino and De Niro in the coffee shop will stop your heart. You will be awash in awesomeness.
- If you don’t like occasionally talking about movies along with your investment strategy then I can recommend some very dry, very technical, but very good financial newsletters. Feedback@TheDraconian.com is how you do that.
Pitchers and catchers reported to training camp this week which means baseball season is about a month away.
We’re going to talk a little baseball today, but don’t worry, it has everything to do with investing. You’ll see!
First let’s take a quite run through the major markets. There are a couple little things to watch for right now.
Market Recap
It was another quiet week. Stocks continued to drift higher:
The Bernanke Put seems to be in full effect. What happens when the Fed starts to tighten policy — there’s now a 50/50 chance of a rate hike by December, you know — and withdraw all this epic stimulus? Who knows. We’ll worry about it then!
And bond yields seem to have topped out until the next catalyst:
I’ve been watching the emerging markets lately too, and these have been showing clear weakness. Emerging markets can be good leading indicators and if you’re looking for reason to get bearish about the markets over the short run, this is as good a reason as any.
Here’s a chart of the iShares Emerging Markets index:
Keep an eye on this or something like the Hang Seng Index. This could just be a buying opportunity for riskier assets but if it violates support around 3-4% below this level, that could be a bad sign of things officially rolling over.
There are relatively few things in the world that I’m bullish on, but one of them is high-quality companies that trade at sensible valuations. Many of these companies live in the S&P 500, so there’s a chance that a shift in preference for these kinds of stocks could be the reason behind the recent divergence. If you’re bullish on the markets, be bullish about good companies not the high-volatility momentum junk that led the way in 2010.
Volume is another thing I’ve been watching lately and lately it’s been uncharacteristically low. Nowadays in the world of electronic exchanges and high-frequency trading, volume isn’t the fascinating and useful indicator it once was. But it does warrant casual monitoring and besides, the markets have just felt boring and listless the way they always did in low volume environments. The first quarter is usually full of action and excitement, but it feels an awful lot like summer out there, monster snowstorms notwithstanding.
Environments like these tend to linger and linger and linger until one day it all changes on a dime. I know it’s hard not to fall asleep with complacency in a market like this, but do try to stay awake and vigilant out there.
Sometimes we talk about the details of the market and sometimes we talk about about broad strategy. Sometimes we talk about philosophy or movies! Today we turn our attention to baseball.
Everything I Know About Investing I Learned From Fantasy Baseball
I’ve never really talked about it on here before, but one of my favorite things in the whole world is fantasy baseball. I know, huge geek, right? I started playing back in college and was pretty much hooked right away.
I like it because it’s a game and I’ve spent my entire life playing games from Chess to Cribbage to all this cool stuff coming out of Germany. I like to think and strategize, and I like to compete. I am a firm believer in famous investor James Altucher’s suggestion to “learn lots of games — they turn you into a killer without ever having to hurt someone.” Games are wonderful things for countless reasons. Whether you want to be a killer or just chill out with your friends.
If you’ve never heard of Fantasy Baseball before, it’s pretty simple. All you do is assemble a lineup of baseball players and as they generate statistics in real life — hitting home runs and such — your fantasy team generates points. Like most games, the guy with the most points at the end of the season is the winner. In this sense, it’s a lot like portfolio management. All you investors at home out there have a certain amount of money to work with and you need to allocate this across a lineup of investments.
There is deep strategy in how you assemble this lineup of investments. Different investments are good at doing different things and some investments make for better pairs than others. The goal is to have a team that is strong and balanced as a whole. The individual investments (and ballplayers) are merely tools to accomplish this objective. Making money and protecting those profits are what we are all playing for.
I think the real reason why I get so excited about Fantasy Baseball is that it is a game that is based 100% on the ability to identify value. This is another one of the key principals when it comes to successful investing. Both games are played over the long-run. Investors that are better at identifying true value tend to outperform those that are not. Old school legends like Warren Buffet and Benjamin Graham come to mind, as do modern day value gurus like Bill Ackman and Whitney Tilson.
I have no idea if these guys play Fantasy Baseball, but they’d probably be good at it. They each have a knack for the fundamentals that move markets up and down, and they are particularly adept at identifying investments that are either under-appreciated or over-hyped. Because that’s how you win at Fantasy Baseball. You ignore the players that are “expensive” in terms of what you have to pay to acquire them and what they’ll deliver in terms of statistical performance. And you chase the players that are “cheap”, the ones that cost relatively little in terms of the output they’ll actually deliver for your team.
I also like it because it’s played out over the course of an entire season. A 162 game season is a long time, and stats junkies like myself appreciate this. The law of large numbers tells us that with a bigger and bigger data sample, the average result moves closer and closer to the expected value. In this case, the expected value is usually a baseball player’s historical mean performance. St. Louis Cardinals slugger Albert Pujols has averaged about 40 home runs per year for ten years. (With low standard deviation, too!) It’s a pretty good bet that this season he’ll hit somewhere around 40 home runs once again.
The same mechanics are at play in your investment portfolio.
Reversion to mean
This is one of the granddaddy principles of investing. Over the long run, markets oscillate around a variety of historical means.
I love this next chart and I’m sure you’ve seen one like this before. It’s a chart of the total return of U.S. stocks for almost two hundred years and it’s log-scale. Log-scale is just a fancy way of saying that “slope matters”. Two huge things will immediately jump out at you:
The most obvious thing is that this line goes up and up, from the lower left hand corner to the upper right hand corner. I dunno, maybe you had some doubts or conspiracy theories, but it should now be clear to anyone and everyone that over the long run, stocks make money. They go up in value over very long periods of time and I even have a simple formula to calculate exactly how much. It’s called [GDP + Dividends + Inflation]. Over the long run, that’s how much the stock market makes. It’s closer to a law than you might think.
The second thing you’ll notice is that the chart fluctuates up and down above and below an imaginary trend line. It does it both over short periods like a year or two and also over bigger cycles. Notice how far above that invisible trend line the market went from 1922 to 1929. Wow! The Great Depression corrected that. Look at how far below trend line stocks were during the Civil War. The post-war reconstruction boom fixed that too. Here in 2011 you can see that we are above all sorts of long and medium term trend lines. This is part of the reason why I am so cautious about things.
I mentioned that equation [GDP + Dividends + Inflation]. Those three elements are all-powerful but there’s actually a fourth variable hidden between the lines. It’s called “multiple expansion”. This is the special sauce that brings the whole meal together. ”Multiple expansion” is just a fancy way of saying how much appetite for risk the average investor has. The “multiple” comes from the price-to-earnings multiple, which is a measure of how much an investor is willing to pay for a dollar of earnings.
In 1981 investors were scared to death and they were only willing to pay about $7 for $1 of actual earnings. In 1999 everybody was dancing naked in the streets and paying over $40 for $1 of earnings.
Price-to-earnings ratios come in all sorts of different flavors. But my favorite is the Shiller PE. Robert Shiller is one of my economic heroes and the flavor that he uses is a normalized PE. He looks at average earnings over the previous decade which smooths things out quite a bit. He’s a pretty snazzy guy, so he gave it a snazzy name, the “Cyclically Adjusted Price-to-Earnings Ratio”. Snazzy name or no, something like this is considerably more useful for guys like me who are more interested in the 162 game season than what happens tomorrow morning.
Here’s a chart I hastily threw together:
Pretty cool, huh?
In case you were wondering, this chart is basically a when’s when of awesome times to buy and sell. In fact, I’m not sure if there’s a chart or an indicator in the world that does a better job getting a long-term investor in and out of the market. You can make a case that this is the only chart that matters. It answers the question whether the stock market is cheap or expensive. That’s what we all want to know, right?
The Shiller PE is at 23.69 today. The average is down around 15. Within the context of the last decade, stocks are somewhat reasonably priced. But within the context of a larger history you can see that they are still pretty expensive. You can ignore that history if you want, but I won’t. If I know anything about the market it’s that this chart will eventually revert towards its historical mean. It will do that one of two ways.
- If earnings increase dramatically and the market stays relatively flat. A bigger denominator (E) is one way to make the PE ratio go lower towards its historical mean.
- If market prices fall back in line with normalized earnings. A smaller numerator (P) means that the market goes down in value.
I said that this will eventually revert towards its historical mean but you can see that the “eventually” could mean ten or twenty years. This is the backdrop against which all long term investment decisions must be made.
How to win
OK, that’s enough about wonkish stuff like earnings multiples. I know what all of you guys really want to know is how to win your fantasy league (and how to build a good investment portfolio).
One of the things I like to do in fantasy baseball is to make a list of all the players that my opponents hate. It’s usually full of players that are boring or old or on teams that nobody really cares about. Then I go down the list one by one and relate each player’s expected output to what it will cost me to acquire them. The guys that are expected to deliver the most bang (return) for the buck (risk) are the players that I want on my team.
Now, obviously some players are hated with good reason. The players that I am always most afraid of are the ones that are injury risks. This is bad because injured players give you zero production. You pay money for them and get nada in return. In both investing and fantasy baseball you need stuff you can count on, especially at the core of your roster. For the most part, I categorically avoid players that are at high risk for injury and I categorically avoid investments that have an above-average chance of going *poof*.
That’s just my managerial style. In the past I have played around with high risk players and high risk investments and I found neither were to my liking. Some of my league-mates are pretty good at these strategies and there are plenty of investors who know how to handle the spicy stuff. You read The Draconian every week. You know the drill: find something that works for you.
There are other reasons why certain players fall out of favor, but the most peculiar is when they have a bad season, one where they generate statistics below their historical averages.
In 2007 Albert Pujols hit “only” 32 home runs which was about 25% below his four-year average. When it came time to assemble our 2008 fantasy baseball teams, a lot of people were a little bit down on Pujols and thought that maybe he shouldn’t be a number one pick. Some people even had very elaborate and convincing cases for why you should take somebody else with your first pick instead.
But lo and behold, Pujols picked up the power back up in line with his historical average. He smashed 37 home runs that season and hit .357 to boot! The season after that he would lead the majors with 47 home runs. Fantasy baseball players everywhere were bummed out that they didn’t buy low on Pujols after a slow season. Even good investments have extended streaks where they struggle.
As I go through that list of players that everybody else hates, I pay special attention to whether they are down simply because they’re coming off a bad year. Most of the time that kind of hatred is unjustified and an opportunity to pounce.
What investments do people hate right now?
Real Estate.
I won’t go too much in depth because we just talked about it a few weeks ago. Remember? We discussed Bill Ackman’s “How to Make a Fortune” and much more right here.
Everybody is down on real estate but I feel like the worm is starting to turn. I saw that a record number of deals were cash deals in December. Here in Reno about one in four houses were purchased for cash but in Miami over half were! Even in expensive San Francisco, over 20% of sales were cash.
Keep in mind that most of these deals were at the lower end. There was not a record number of people paying cash for million dollar homes. The bulk of these were sub $100k properties. Who pays cash for sub $100k properties? Investors. Now, this is different from the “investors” in 2005 who were borrowing 110% of the home’s value with the intention of flipping it in six months.
You don’t pay cash for an investment property if your goal is to turn around and resell it. For that strategy to make sense you need a bull market and lots of leverage or you need to be shopping aggressively on the courthouse steps. The kinds of people who pay cash for an investment property use fancy spreadsheets. These spreadsheets determine how much they can rent the property for, how much the expenses and taxes on the property will be, and various other bits of financial arcana like price per square foot and weighted cost of capital. Then the spreadsheet calculates a rate of return. If the number is big, the investor buys the property and rents it out.
You also don’t pay cash for an investment property if you think that prices are going to go down. I’m not saying that all of these buyers are super-sophisticated, but I am saying that they’re probably more sophisticated than the people on “Flip This House” in 2007. In a sense, the smart money is starting to buy real estate right now. They’re being careful about how they’re doing it and a lot of people are paying cash. (Even with historically low interest rates!)
Housing starts also ticked up in January and as we’ve outline in previous newsletters, this is something to watch. The single biggest issue in the real estate market right now is this boatload of excess supply. But don’t forget that the U.S. still enjoys a growing population and all the privileges and rights thereunto. At the current trend, we’re going to wind up with a major lack of supply later in this decade. I saw this morning that KB Home is opening 70 new communities so they notice this too. That trend probably won’t continue.
These homebuilders have been eviscerated after a few disastrous seasons. But if you look at their performance in more normal environments — their historical mean — the hatred of these guys might be a little unjustified.
A watchful eye
Real estate isn’t the only thing on the list of investments that everybody hates. There’s Japan. On that list there is also, quite interestingly, cash. As I move through the 2011 fantasy baseball season and continue to comb through this list of players that everybody hates, I’m going to be mindful to do the same thing about investments.
In fact, let’s make that our theme here at The Draconian for 2011. ”Stuff that the rest of the world hates.” I like that, and I like fading the mainstream. Professionally, it’s worked out pretty well for us over the years. And we know from fantasy baseball that there is indeed value in this strategy. So we’ll dig through this pile of under-appreciated investments and see if we can’t unearth some hidden gems.
Stay tuned. Make sure you sign up for the newsletter by e-mail. We send you exactly one e-mail per week and never share your address with anybody else. We hate spam and value privacy just as much as you do. We want to, like, grow our subscriber base, not piss them off.
In the meantime, hit me up at Feedback@TheDraconian.com if you need one more guy for your fantasy baseball league! I’m always on the lookout for people that share my passions and like to talk strategy — whether that’s baseball or investing.
- From Fantasy Baseball we learn that there can be a lot of hidden value in assets that everybody else hates. We also learn that it’s about winning over the long-run and assembling a balanced portfolio of players and investments.
- “Reversion to mean” is one of the granddaddy principals in all investing (and baseball). Understanding it can make you a much better investor, getting you in and out of markets at the right time.
- Real Estate is something that pretty much everybody hates right and there might be some opportunity.
- Stay tuned through 2011 as we continue our search for ways to fade the mainstream.
For a while now we’ve been saying that this market seems to want to go higher. And higher.
We’re all still drunk from the robust economic data from last year and giddy about the promise of a recovery that might be “self-sustaining”. Whether that kind of recovery is actually here matters not to the makers of central policy. It’s pedal-to-the-metal and we’ll figure out the rest later and deal with the long-term consequences later. It’s all very American, when you think about it.
So the Fed is in full tilt boogie right now and the market is rocking and rolling right alongside them. It’s silly to fight it! Markets like these are why short-sellers are such a profane and generally-miserable bunch.
In the land of full tilt boogie, if you know how to dance, you gotta get out on the dance floor. Who cares if everybody out there looks and sounds like Chuck Prince, he who authored one of the most terrifying quotations in modern finance:
When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.
- July, 2007
When he first said that, everybody laughed and thought the idea of Chuck Prince dancing was just plain silly. We still had a sense of humor in 2007. Then the crisis hit and we looked back on those words with shock and anger. How could those dirty bank CEOs have been so irresponsible!?! Now, as we move further away from the crisis lows and rediscover our love of dancing, we reflect on those words and say, “Here we go again.”
Me? I hate to dance.
Once upon a time I was young and sensual too. I have more than a few memories from inside sweaty, basement nightclubs back in L.A. When you come from a small town and wake up in a big city full of energy and physical beauty these are the kinds of things that you do. But every weekend I would spend most of my time in the corner, drink in hand, utterly entranced by the rhythmic throb of the dancing mass yet sad that I wasn’t a part of it. Such a strange place to find loneliness.
Eventually I made my peace with that.
Being able to stand comfortably and confidently on the sidelines was one of the best lessons I ever learned. I found so much more happiness and success when I did the things that felt right, the things I was good at. It may sound cheesy, but it’s self-knowledge like this that will make you a more successful investor.
Look: if you like to dance, dance. If dancing makes you anxious, come share a drink with me in the corner. When the financial dawn breaks and the party crashes to a stop on the DJ’s final beat, it’s entirely possible that all you dancers will have had more fun. But it’s up to you to decide whether that’s worth being beaten out the door by guys me.
One of us will have made more money — or lost less of it. I haven’t the foggiest idea who that’ll be.
And that’s as honest a perspective as you will ever hear in the financial industry. The dress code here may be black tie and the liquor may come from the top shelf, but finance is a nightclub full of dishonest pickup lines and lusty, unscrupulous intentions. The goal is to move a dollar from your pocket to theirs and whether that’s done openly on the dance floor or privately in the bedroom matters not.
May as well have fun with it and do what feels right to you. My position here is not to make value judgments. I lived in L.A. for six years! That pretty much disqualifies me as any sort of authority on values. I’m just here to give you the freedom to follow your gut and remind you about accepting responsibility for your actions.
There are many answers and whether you like it or not you will find yours.
The Music
Unfortunately, the one question that can’t be answered is the one that everybody cares most about. When will the music stop?
In that question lies the greatest myth of finance and investing, that you can dance and have fun for a little while and still get out before the cops arrive. Selling at or near the top is so difficult that most say it’s impossible.
Every once in a while you’ll get lucky and time it just right. Sometimes you’re out too early and you find yourself on the sidelines again watching the dance floor with envy and loneliness. But usually you’re out too late, and, like the drunk stumbling for Advil the morning after, your mind swirls with regret for having partied too hard for too long. The losses in your portfolio make you swear you’ll never make the same mistake again. We all had quite a hangover in early 2009.
I can tell you one thing about when the music stops: it tends to stop abruptly, justlikethat. And its true reasons for doing so are often vague and tenuous.
Trini & I were having an interesting discussion in the office a couple of weeks ago about Egypt. I’m sure you’ve all been following the situation over there; it’s actually been developing for several months but all of a sudden everything seemed to hit at once in the financial media. Despite all the visual similarities to the Greece meltdown last year –right down to the non-stop video of rioting Egyptians and noticeably-jittery anchors — the revolts in Egypt had basically nothing to do with the global economy.
It proved a point that we’ve been talking about on here for a while and one that we frequently debate inside the office too. When the market feels like selling off, it sells off. And it does it dramatically. All at once. And whatever happens to be going on that day takes the blame. The effect precedes the cause.
Every day you get home from work, grab a beer from the fridge, and sit down at your computer. Once you’re done doing Facebook, maybe you’ll pull up MSNBC.com or whatever and check and see if anything important happened today. Usually, in the business section you’ll see that the market went up or down for some particular reason. Yesterday the Dow gained 6 points. Why? Does anyone remember? Or care? The situation is still getting worse in Egypt!
The business editors at MSNBC.com have to come up with a story to tell, something to explain the action. But the simple answer is that more people felt like buying than selling.
Over the long run, economic fundamentals do matter a great deal. Indeed, they are the most important factor in which way the market chooses to travel over the long run. But on a day-to-day basis, things like Egypt or the monthly jobs report or the my old economic flame, the ISM Purchasing Manager’s Index matter a lot less to the day’s movement than you might think.
Anyway, the real point here is that it’s important to understand the current psychology of the market. It’s manic depressive. Full tilt boogie one day. The-apocalypse-is-nigh the next.
It wasn’t so much like this in the years prior to the crisis. I wish I understood it. Perhaps it’s part of the healing process as we get over the psychological trauma of the crash. The irony is that once we’re fully healed, we’ll be ready to make all the same mistakes to cause another one.
And speaking of markets with a history of manic depression…
The gold price
Last week I caught Jim Grant of Grant’s Interest Rate Observer in an interview on Bloomberg.
He said one of the most fascinating things I’ve ever heard about gold. Keep in mind that he’s bullish on gold, too, and is a staunch supporter of the gold standard.
Gold is not an investment asset. It is a speculation on a certain set of monetary outcomes, mainly on a chaotic set of monetary outcomes. Imagine the gold price being 1 divided a number we’ll call the world’s faith in the institution of Ben S. Bernanke, Ph.D. — that’s the gold price. The gold price is now $1,300. It will yield as much at $900 as it does today at $1,300. There’s no conference calls, no earnings, no price-to-book ratio, nothing. The gold price is a price. It is a concept. It’s not an investment.
Jim Grant’s been around forever, but if you’ve never heard or read him before, he has a way with words. His language is so carefully calculated, so precise, that word nerds like myself can’t help but be swept off our feet by his awkward eloquence. You can watch the whole ten minute segment right here. He also talks about the inappropriate compensation investors are currently receiving from the muni bond market.
I’m on record as saying that gold is in a bubble right now. That’s not to say that it won’t or can’t keep going higher this year and it’s not to say that investors should categorically avoid it in their investment portfolios. But I feel as though it’s very difficult to make the case that gold is not in the middle (or late stages) of something very dramatic and very speculative. And Jim Grant gets to the heart of that in that quote above. Gold is not an investment, it is a price and it is speculation. This is true from a conceptual standpoint, but it’s also true when we look at the data of price action as well as all the anecdotes surrounding it.
I guess I’m speculating that the ultimate monetary outcome may be unfavorable, but not catastrophic enough to justify the highest real gold price in the history of the United States. (With the exception of that little frenzy in 1980, of course.)
More from Bloomberg
The financial industry is populated with “CNBC people” and “Bloomberg people” and if you have no idea what I’m talking about, then what follows will probably have no meaning to you whatsoever. For what it’s worth, I’m not just a “Bloomberg person”, I’m a bona fide junkie.
I told you about Tom Keene a little over a year ago. He used to do a brief segment on Bloomberg TV in the afternoon, “The Chart of the Day”. He’d get up there with his trademark bowtie and horn-rimmed glasses and talk about how “elegant” or “nuanced” this chart or that was, and then drop a whole bunch of heavy-duty jargon about why it mattered. The anchors would smile and nod and thank him for his chart.
I really dug it but the segment didn’t last long. When the financial crisis hit viewers kind of lost interest in elegant charts and nuanced macroeconomic concepts. I seem to remember many of his final charts of the day all having to do with the TED spread or LIBOR/OIS spread blowing out to never-before seen levels. At the time, few of us were entirely sure of what that meant. They were the right charts to be looking at, though. Now we know that when LIBOR/OIS explodes, stop what you are doing and run for the exit.
Someone upstairs at Bloomberg saw a potential gem and so they slid him over to Bloomberg Radio and partnered him up with grizzled radio vet Ken Prewitt. The two of them have fashioned the single best financial program across all media.
The cool thing is that Tom Keene isn’t just another talking head — this is a media guy with a shockingly-deep understanding of not just economics but current events and trending ideas. Because of this, basically every question he asks is the kind you wish you thought of yourself if only you were a little smarter. You can tell his guests love answering these questions too. The interviews are less Q&A and more of an unfolding narrative; he seems to have an intuitive feel for where his guests want to go and the most colorful way to get there.
In a masterstroke of counter-programming, Bloomberg even gave him his own hour long TV show — Surveillance Midday — to compete directly against CNBC’s very popular Fast Money Halftime Report. The shows couldn’t be more different. I really enjoy the Fast Money guys and their funky personalities, but they, uh… trade intellectual heft for action and entertainment. (Again that is not a value judgment, just a simple descriptor.)
Keene’s show is not for the layman, or even the “laytrader”, Fast Money’s target demographic. But if you know a thing or two about finance and have an interest in what the tippy-top of the economic minds are watching and thinking about, then give it a shot. Not only are these economic heavyweights frequent guests, they listen to it when they’re not on. Bill Gross said he tunes in every day on his drive into work and Mohammed El-Erian has admitted to being a huge fan. Same with former SEC-chairman Arthur Levitt and mega-analyst Jim O’Neill, the new chairman of Goldman Sachs Asset Management.
Anyway, if you want to check it out, go to the Bloomberg Radio page for more information. You can listen live on the website or on Sirius/XM for free. You can also subscribe to free podcast snippets in iTunes.
I get the premium subscription package which is $99/year. For that I get all the interviews with all the commercials edited out. I also get the weekly research review where he goes over the most interesting research essays of the week. And the weekly economics roundtable where he sits down with a few other Bloomberg editors to banter about the big economic news of the week. It works out to about two solid hours of content per day and I can choose exactly what I want to listen to.
Since it’s delivered as a podcast, it goes straight to my iPhone. I listen every afternoon while I walk the dog. I listen on the weekends when I vacuum the house and scrub the tubs. And I plug it into my car and listen whenever I drive around town. I even put it on with Mrs. Draconian when we drive up to Tahoe. If the topic is interesting or relevant — like when they talk about retail sales data or home prices — she’ll listen along and offer up her own commentary. ”Stupid freaking strategic defaulters!” or “This analyst knows her stuff. Boots are hot right now. You should invest in boots.”
But usually she just falls asleep.
Your mileage will undoubtedly vary. You either find this kind of thing totally awesome or a complete bore.
I simply mention it to remind you handful of economics geeks standing on the sideline that you are not alone.
Not everybody enjoys dancing with the herd.
- The Fed is in full tilt boogie right now. They’re doing everything they can to get the market higher and keep the economy going. They’ve made it clear they plan to err on the side of too much rather than too little. It’s uncertain exactly what the consequences of too much stimulus and too accommodative policy will be, but we can probably guess by looking at past bubbles that were indirectly inflated by the Fed.
- Gold is a price not an investment asset. By definition, it is speculation, and what we have seen in the gold market in the last few years is increasing speculative behavior. It’s foolish — worse, dogmatic – to categorically dismiss any talk of a bubble.
- Check out Bloomberg Surveillance if you want to know what the professionals listen to. You won’t find any easy Jim Cramer-style investment answers, but Tom Keene and his guests will help you connect the dots between economic theory, finance, and investment.
I’ve written over and over again that we are not financial advisors. I mean, technically we are; our firm is registered with the SEC as an Registered Investment Advisor. But it’s not our business. We just manage a couple of hedge funds. What we do is just one piece that investors use in the rest of their portfolios.
Bob Barone is a financial advisor. And a successful one at that. He and his son Josh run Ancora West Advisors. Their office is right down the street from us and, as long-time Nevada residents, they’re something of kindred spirits.
No surprise, their view on the markets and the industry is similar to ours and a bit outside the mainstream. I sat down with them for a conversation a couple weeks ago and brainstormed about something new we might try here on the site. What follows is the continuation of our conversation via e-mail.
I think you’ll enjoy it. But in the meantime, let me know what you think about this idea, conducting occasional interviews to bring in some additional perspectives while retaining focus on the issues that we usually discuss in this space. Feedback@TheDraconian.com goes straight to my desk.
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Hi Bob, thanks for taking the time to do this interview.
We should probably begin with what’s obvious to anyone that stops by your place for a visit — it’s one of the most intriguing offices I’ve seen! And I’ve visited all sorts of traders and money managers around the country. I’ll let you describe it and tell us why you guys made the decisions you did when building out your office.
The office contains all of the standard features that you would find in money management firms across the country plus one unique feature – a kitchen that many would die for.
The idea is that, at any social gathering, especially in a home, the crowd tends to gather in the kitchen. It is just more comfortable. When potential clients come for the first time, we feed them. One of our principals is a hobby chef and has taken cooking lessons in Italy, Ireland, Napa, Australia, and Hawaii. Rather than putting them in a stuffy conference room and bombarding them with invasive questions, the potential clients open up voluntarily as the conversation takes its own course.
The kitchen itself is set up much like an eating bar – all granite – that seats six in a semi-circle. The range is inside the semi-circle, so that the principals can cook and have discussion at the same time. The sink and other appliances (oven, refrigerator etc.) are behind the semi-circle, and the wall above the sink area is uniquely tiled. We find that the kitchen is a great help in closing clients.
Of course, our track record and approach also help.
While we’re at it, let’s also get a brief introduction out of the way. Can you briefly tell our readers who you are and what you do?
Ancora West Advisors is a boutique RIA. We are value investors. Our clients are mainly individuals and all client portfolios are managed to specific client risk profiles which are reviewed with clients as frequently as the client desires. And our asset allocations are greatly influenced by our macroeconomic views, not only of the U.S., but of the world.
We believe that we treat our clients like family members. Unlike big firms, we do not take fees (12-b-1 or any other kind) from other managers or mutual funds. Our only fees are derived from assets under management, as opposed to putting client assets into investments because of the fees rebated from those asset managers. So our interests and those of our clients are tied together in lockstep. As a result, there are no hidden fees and the all-in cost to the client are on the low end of investment advisors. So the only way for us to increase our revenue stream is for client assets to grow and for clients to recommend their family and friends to our firm. We also do all of our own basic research on all of the assets in client portfolios. The principals of the firm have over 50 years experience in the investment business including a Ph.D. in economics and frequently publish blogs on macroeconomic topics in a national venue.
On that topic of macroeconomics, describe your macro thesis more broadly. What kind of framework are you guys using to make long-term strategic decisions for your clients?
Given the risks we see in both equities and fixed income, we have moved most of our client portfolios into significant cash positions. It has been difficult as the equity markets continue to grind upward, but, sooner or later, the fundamentals will play out. We don’t want to be in momentum equities when this market turns. The ride down could be quite dramatic and rapid. Same is true of bonds.
I’m glad you mentioned this. I think this is one of the hardest things for a professional asset manager to do, to stand on the sidelines in the midst of an exciting, dangerous rally. Your rational brain knows that the risks are too great but it’s still tough to fight the emotions seducing you to participate. Do you guys ever get any blowback or frustration from your clients about this? Or do they tend to share your mindset about these things?
This is, perhaps, the most frustrating part of being a money manager.
There are legendary managers — John Hussman, Jean-Marie Eveillard, and Marc Faber — and even some economists like David Rosenberg who see clearly into the future way ahead of the herd. As a result of their clairvoyance, they underperform what they see as an irrational market, sometimes for quite some time, until the herd also sees the fundamental realities. Bob Farrell, formerly of Merrill Lynch, has 10 rules for investors – one of them is that the market can remain irrational longer than an investor can remain solvent!
We are not market timers. We are value investors. We would rather lose a client than lose a client’s money.
I suppose it’s ultimately about the relationship between the client and advisor. Eventually, clients wind up with advisors that have similar values and mindsets. Those that don’t match go somewhere else. The advisor just has to always focus on his job of knowing the client and asking questions about the economic fundamentals, doesn’t he?
As this market has grinded higher, we have questioned ourselves and often redone our analysis. Each time we have come to the same conclusion. Both monetary and fiscal policy are on what we believe will prove to be disastrous tracks. The seeming upturn in the US economy is built on government stimulus which appears to be coming to an end. And currently, the equity markets are significantly overvalued.
If, as a result of the Fed exporting inflation to the emerging markets, those countries adopt capital import restrictions and tighter monetary policies, world economic growth will be stifled. This will also have a negative impact on the prices of all commodities, except perhaps gold, which, in dollar terms, is going to continue to rise as long as the Fed prints money and the federal government runs trillion dollar deficits.
Meanwhile, in the face of falling home values, rising foreclosures, state and local fiscal austerity, rising food and gas prices, and continued high unemployment, growth in the US will be slow for a significant period of time. When the markets finally recognize this, a correction will occur.
Commodities get all the attention right now, but real estate is a big force behind this backdrop of deflation worry. Will the money printing change that?
The underlying private economy is still deflationary. But the Fed’s insane policies of dollar debasement will only serve to drive interest rates up and make it even more difficult for the private sector to recover. Massive money printing has NEVER worked in the history of the world and just leads to worse problems down the road – Bernanke clearly believes that “this time is different”!
Meanwhile, the uber-rich on Wall Street get richer and the middle class consumer suffers with rapidly rising energy and food prices which the Fed ignores because it isn’t in their “core” concept. As if we don’t eat and drive on a daily basis!
High quality multi-national companies — those with significant non-dollar sales — will benefit from dollar debasement as the translation of non-dollar revenues is a higher dollar figure even if physical sales haven’t changed. Such companies could be of value if they have low debt levels, rising top line revenues, a niche product that will be around in 20 years, no cost issues, and no pension issues. Gold and other commodities are also of value for the long run as long as the US continues its current monetary and fiscal policies. Lately, the prices of these have pulled back slightly, but their long term prospects appear to be for higher prices.
That’s a great point about the specific value of high-quality multi-nationals. What about the rest of the market? Is what we have seen lately and since the March 2009 lows the foundation for a new super-bull market in equities? Or is it just froth?
Frankly, we view the markets as overvalued and highly risky. This includes both stocks and bonds.
Unemployment is too high and likely to remain sticky at existing high rates as state and local governments lay off scads of folks to meet balanced budget requirements. The housing market appears to be taking another dip and the value of the home is more important to the middle class than is the stock market — over 60% of American famileies own a home while only 20% of Americans have significant attachment to stocks. If housing prices continue down, the impact on consumption will be negative.
Do you see value anywhere else in the market?
Emerging markets appear to be doing okay – but the Fed’s money printing is playing havoc there. Brazil has seen huge dollar investments, as investors look for opportunity elsewhere with the excess dollars the Fed has created. This causes the demand for Brazilian Real to rise, pushing its price up in terms of other currencies and making Brazil’s exports more expensive. Thus, the Fed’s dollar debasement policies severely impact other countries, and they don’t like it – so they take actions to limit dollar investments – the beginning of trade wars.
Back in the day it seemed like all that mattered were growth rates and economic fundamentals. But policy is such an important driver right now isn’t it?
The Fed has embarked on an insane policy to devalue the dollar, and, as a result, we could see significant increases in interest rates as a result. Note, the rates won’t be rising because of demand – but because of dollar debasement. Why should a foreigner buy a 10 year note yielding 3.5% if it is likely that the dollar will lose purchasing power at a faster rate? In order to convince them to purchase, the coupon rate has to be higher than the rate in the loss of purchasing power. So, there are significant headwinds ahead for the U.S.
Fiscal policies are a mess at all government levels. 86% of federal expenditures — $3.0 trillion! — are in “untouchable” categories: entitlements, defense, and interest on the debt. Meanwhile, tax revenues are a paltry $2.1 trillion. Thus, even if all other federal spending goes to zero (yeah, right!), there is still a $900 billion structural deficit. The GOP’s proposed $100 billion reduction, which is likely to get cut in half, is but a drop in the bucket.
Also, if interest rates go up just 2 percentage points, the interest cost of the debt skyrockets – like by $500 billion. How long can we run trillion dollar deficits primarily financed by foreigners? My answer is – not long. Thus, the day of reckoning is coming – and it appears to us that it will be soon.
The Fed’s is in a major bind right now. They hold a ton of assets and the problem is that these assets take a hit in value as interest rates rise. The catch is that since these assets are all bonds, if they were to try and get rid of these things and sell them into the marketplace it would push rates upwards and hurt the value of everything else on their balance sheet. Do you think there is a way out of this?
One of the major conclusions of our macroeconomic analysis is that today’s monetary policy is going to cause future instability in the real economy. It is widely recognized that Greenspan’s response to the shocks in the late 90s and early 2000s (overly easy monetary policy for way too long) was a large factor contributing to the housing bubble.
I’ve heard that distinction elsewhere, too. That what we had really was a credit bubble, the side effect of which was a separate and contingent bubble in home prices. A disaster in the mortgage backed security market was another one. Again, enter the Fed. Right?
It is clear that the Fed purchases of MBS in ’08 saved their friends on Wall Street.
One has to ask what would have happened if AIG, Morgan Stanley and Goldman Sachs had been allowed to fail. The answer is that there would have been an intense period of financial chaos, but someone with capital would come in to fill the void, and today we would be far better off. The new companies would not take the risks that the Wall Street banks take today, because the new folks know that they would be allowed to fail if they screw up. No more moral hazard.
Had the Fed followed its original intent and began to unwind its ’08 purchases in the middle of ’10, they perhaps could have restored confidence in their ability to manage monetary policy. But, their balance sheet has become way too large, and the amount of capital as a percentage of those assets is now about 2%. Remember, they close community banks when those banks’ capital fall that low.
Yeah, I heard the other day on Bloomberg that the New York Fed was levered 80 to 1. 80 to 1! I guess rules on leverage and capital requirements don’t apply to central banks, do they?
Sometime this year or early next year, Ron Paul, chairman of the House subcommittee that oversees the Fed, will require a public audit of the Fed. At today’s interest rates, the market value of the Fed’s assets is significantly below what they paid for them. So on a mark to market basis, the Fed will be shown to have little or no capital. That will trigger significant responses from the international community and from investors. When this occurs, bond prices will tank, interest rates will rise, there will be foreign criticism, and likely, the stock market will react negatively.
There will be an upward spike in the prices of precious metals and commodities if this were to occur.
It sounds like everybody who invests needs to understand policy and its implications on the world ahead. Understanding policy and all the macroeconomic variables is difficult for amateurs to understand, but I’m not sure it’s the most difficult thing.
In our experience with both the average investor at home and some of the best trading managers in history, we’ve noticed that taking responsibility for one’s actions is one of the most difficult things to grapple with. Personally, I believe that one of the reasons amateur investors seek out professional guidance is not just to get advice, which they need, but also the subconscious desire to have the freedom to abdicate the responsibility of being wrong and making a bad investment.
Taking responsibility for our actions is very difficult and this is an existential reality that we all ultimately have to make an uneasy peace with whatever our line of work. How do you guys handle the responsibility of sometimes getting it all wrong?
Taking the thought a step further, the “no fault” attitude has now permeated the large investment houses too.
With a few simple questions on a laptop program, investors are segregated into boxes and their funds are shuttled off to outside money managers. Managers who, by the way, lavish fees and business back to those large houses. If, at the end of the measurement period, one of the managers isn’t performing, rather than studying why, the local rep simply says that they will replace that particular manager with someone who did perform well. In other words, the rep says it isn’t his fault that the outside manager didn’t perform and that he will fix it by chasing one who did.
There is no doubt that over the years we have made some poor investment decisions for client portfolios. We are surely responsible for these and admit to the clients that the choice was, in hindsight, a mistake.
We have an investment with a very secretive, very famous hedge fund manager out on Long Island. We went out to meet with them and they told us with one of their funds they expect to be wrong about 40% of the time. They make mistakes with their portfolio every day. What’s important for every professional is that he have a plan for how to deal with the mistakes he will inevitably make. What kind of things do you guys do?
As a matter of practice, when we do have a position begin to deteriorate, we re-examine our rationale for having bought it in the first place, and we try to figure out if we missed something. If we decide to keep the position and it continues to deteriorate, we continue to re-examine.
But there does come a point, usually around the 20% decline mark, that we do sell, lick our wounds, and live to invest another day. These, of course, are tough decisions because we have to admit to ourselves that we were wrong about this one.
And that’s why you’re a investment professional, right?
Amateur investors who refuse to sell a particular holding until it rises back to their buy-in cost simply do not understand the object of investing – i.e., to deploy your funds to the best assets you can find. By taking the loss and reinvesting in another asset that has more potential than the one you are in makes the money back much quicker than waiting for the bad choice to recover.
But, in general, we do not look at individual holdings when evaluating a portfolio’s performance. If we are right in our selections more often than we are wrong, the overall portfolio will perform well. And it is the overall performance that counts.
It is in this that we take comfort.
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The mention of securities, bonds, commodities, foreign currency, foreign securities and investment strategies in this interview should not be considered as an offer to sell or a solicitation to purchase any specific securities or investments or implement an investment strategy. Please consult an Investment Professional on how the purchase or sale of specific securities and investments can be implemented to meet your particular investment objectives, goals and risk tolerances. Investments in precious metals, foreign currencies, foreign securities and similar securities or commodities are subject to additional risks. It is important to obtain information about these investments and understand the risks associated with these investments prior to investing.
The information and investment strategies mentioned here are and can be time sensitive. This information may not be current in the future due to changes in the economic factors, monetary and fiscal policy or changes in other factors not mentioned here. Ancora West Advisors cannot predict when any factors may change causing information to become outdated.
