"A World Class Value Manager" Finds Current Investments Limited

The Reformed Broker, Joshua Brown, offers Some Anecdotal Stuff from a World Class Value Manager that strikes a chord with my feelings about current investment opportunities. Here’s a key portion of the post:

I ask them why the almost 20% cash position, is there something they're seeing in the macro data or the headlines that their peers (who are much more heavily long) don't necessarily see?

No, they tell me, they don't play that game in terms of trying to read the macro tea leaves or anticipate the political outcomes in the 17-nation Euro Zone.  Rather, they've got a 20% cash pile because as they've sold things, they've not been able to find replacement candidates worth buying given their bottom-up approach.  It's a combination of stocks not being cheap enough around the world to offer the "margin of safety" they live by and earnings growth being non-existent across much of the global landscape.

One pocket of interesting buys is in European multi-nationals that do most of their business outside Europe.  These stocks are being pressured because of the Euro exchanges they are listed on despite the fact that they don't have the perceived exposure to Euro economies that people assume.

My personal cash position has been well above 20% for some time now since the focus of my portfolio is based on a 3-5 year time horizon. At each dip in the market, I’ve picked up a couple new stocks or added shares to positions, only to sell some of those positions as markets rallied back near current levels that remain uninspiring. Multiple expansion has been a primary driver of this year’s US market rally as corporate profits enter a recession. If this trend continues, as I expect, further multiple expansion seems unlikely and the potential for contraction remains well outside most investors’ radar. 

Regarding the pocket of opportunities in Europe, I have also been watching several large multi-nationals come under intense selling pressure as specific country’s markets get sold. While I don’t expect sentiment to change in the near future, investors will likely be rewarded for their patience. Although the “world class value manager” remains a mystery, based on these anecdotes, I definitely wish I had more access to his investment outlook and fund.  

Hugh Hendry - The Crash Ahead and Opportunities of a Lifetime

Hugh Hendry is one of a handful of legendary investors whose views on markets are always worth strong consideration. Among that group, none are more determined to generally remain out of the news. Luckily, Hendry was recently willing to discuss his opinions with the Financial Times. While he remains bearish on the BRICs and Europe, his take on the US is slightly more optimistic. But don’t get too excited:

He believes that financial markets are single-digit years away from a crash that will present investors with opportunities of a lifetime. “Bad things are going to happen and I still think the closest analogy is the 1930s.”

Professional money managers may not have the luxury staying defensive but, for other investors who believe Hendry’s view may prove true, the lesson is clear: Preserve capital.

Dynamic Hedge - Fundamental Top-Down Macro for the Brain Damaged

Fundamentals have nothing to do with the market, brah.

Interior decorating is rock hard science compared to economics practiced by amateurs.- Antonin Scalia (never actually said this)

Macro economic analysis can be pretty frustrating.  Many economists justify an attractive annual salary by coinciding, smoothing, and transforming the public into mass confusion.  The sheer number of data releases issued over the course of a year is rivaled only by the number of opinions as to the sensitivity of the economy to each data point.  This makes it nearly impossible for the casual observer or even market professionals to get on top of.  Most investors simply agree with the pundit that makes the most short declarative sentences.  The good news is that most of us already posses the most important skill set of macro economic analysis: the ability to squint.

That’s right, close your eyes.  Now open them up just enough to make out shapes and colors.  This is the correct way to look at any chart originating from a government agency or academic institution.  The data is always of questionable integrity and almost always subject to revision.  Not to mention the host of other statistical problems continuously pointed out and debated by super smart people on the internet.  The point is that you’re never going to see the whole picture in any one report.  All you care about is the general direction.  Most importantly, the general direction you can make out when squinting and glancing at a chart for no more than 3 seconds is the correct one.

I subscribe to the 80-20 principle which states that 80% of the results come from 20% of the causes.  This means that you can safely disregard most of the economic data published and just focus on the important stuff.  As far as I can tell most of the sentiment of the economy is captured in the metrics below (in no particular order).  Most of the data moves so slowly that the trend changes are obvious.

If you’re looking for quick trades and short-term actionable ideas, this stuff probably won’t interest you.  Macro analysis is the long-con.

Read it at Dynamic Hedge
Fundamental Top-Down Macro for the Brain Damaged

If you’re reading this post there is a good chance that, like me, you follow a number blogs and try to keep up with as much news as possible related to the financial markets. With a constant stream of information flowing through social media sites/apps 24 hours a day, 7 days a week, it is often hard to step back for a moment and glance at the big picture. Posts, such as this one, are a good reminder for those of us concerned primarily with the macro picture.

Investing Lessons For My Fellow Generation Y

That is why it is so important that Gen Y investors take advantage of the opportunity to invest, especially in tax-advantaged accounts like 401(k) and IRAs, early on in their careers. When the tax laws are working with you, the odds are put in your favor no matter where you decide to invest. The traditional argument for saving early (and often) in one's adult life is compound interest. Which is of course is true. That being said it is unlikely that Albert Einstein ever said compound interest was "the most powerful force in the universe."

In my book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosophere, I write that "savings is the best investment." By that I mean that it is far easier to generate additional savings through more conscious consumption than it is to generate additional returns, or alpha, from the financial markets. So starting early with a dedicated plan to live below your means is an important part of any comprehensive financial plan.

More importantly as a young investor you get a chance to make your novice investment mistakes while the stakes are, in actual dollar terms, relatively low. Or as said in a different context, "You only get one chance to be a beginner." Wouldn't you rather experience your first bear market when you are 25 and you have $5,000 in your 401(k) plan than when you are 50 and retirement is beginning to stare you in the face? The experience gained when you are young will help you when the stakes are ratcheted up later on in your career.

Read it at The Reformed Broker
Compound Experience, Not Just Interest
By Tadas Viskanta of Abnormal Returns

My interest and excitement for the financial markets began at the early age of 13 when my grandparents gifted stocks (Coke and Disney) as a Bar Mitzvah present. During high school, in the midst of the dot-com bubble, I learned about the stock market and practiced investing online with fake money portfolios. When that bubble burst, I felt fortunate to not have been trading with real money.

After turning 18, having saved up a bit of money, I opened a 401(k) and decided to try my hand at real investing. During college I invested on my own account and continued adding money to my 401(k). Over the summers I enjoyed internships at a day-trading firm, hedge fund and with financial advisors. Following college I took a full-time job as a trader at an options market-making firm. Little did I know that the housing bubble had already gone bust and the stock market was nearing its peak. With real money now on the line, the following 60% drop in stock markets was painful to witness.

Markets have now recovered most of the losses from that second bubble of the decade, but remain at levels first seen 13 years ago. Although I don’t know how the future will play out, I personally am very grateful that my first two bear markets occurred before I turned 25 and had significant money on the line. The experiences have already made an enormous impact, not only on my investing strategy, but also on my career.

For my fellow Gen Y investors, I fully recommend taking the above advice from Tadas to heart. Start early with plans to conserve your consumption and open a 401(k) (You can take money out of the 401(k) without any penalty to use as a down payment on your first home). Only invest a limited amount, at first, until you become aware of how you will respond in a bear market (if you want or need to sell after steep losses you are taking too much risk). Lastly, do not use any leverage until you’ve gained significant experience since it will likely compound losses from your mistakes.

In my opinion stock markets are still not out of the woods from this secular bear market. That means at least one more cyclical bear market before the next secular bull market begins. Hopefully other Gen Yers will take advantage of this opportunity and these lessons to ensure we’re prepared well in advance of the day when retirement comes.

Quote of the Week

...is from legendary investor Howard Marks’ book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor:

“In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, circumstances can change and “sure things” can fail. However, there are two concepts we can hold to with confidence:

• Rule number one: most things will prove to be cyclical.

• Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.”

This week stock markets continued their persistent rise with the S&P 500 crossing 1400 and the Nasdaq topping 3000. Since bottoming in October, stock markets across the globe are up 30-40 percent. Most market participants now seem confident that Europe has turned the corner, China has avoided a hard landing and the US housing market has finally bottomed. With fear subsiding (the VIX dropped under 15), analysts and investors are becoming increasingly confident that the current bull market is here to stay.

Lurking beneath the largely positive economic headlines, actual global economic growth has been slowing. First quarter US growth is once again trending below 2 percent and the full-year outlook is not much different. Europe has entered a recession, with several periphery countries either in or approaching depressions. Spain, not Italy, is struggling mightily and will truly test the resolve of European politicians in the months ahead. China recently lowered their growth target for the next 5 years to 7.5 percent, but current data suggests actual growth is even lower.

Aside from lower growth, corporate earnings estimates for the current quarter and year have been adjusted lower over the past few months. Profit margins also appear to have peaked as input prices continue to rise and productivity growth slows. Lastly, oil prices continue to rise with gas at the pump in many metropolitan areas already over $4 per gallon.

None of this data implies that the stock market is going to stop rising or roll over anytime soon. However, Marks’ cautions us to remember that periods of consistently positive headlines and investor sentiment are fleeting. Soon a time may come when most others have forgotten this rule. Be mindful of protecting your capital in advance of that moment.   

Points of Public Interest

1. The Complexity of Hayek - Greg Fisher comments on similarities and differences between Hayek’s work and complex systems. Complexity theory is a fascinating subject I hope to study in the future.
2. Social Security, the Financial Crisis & Modern Monetary Theory - John Carney continues to display how MMT, in focusing on the monetary system, forgets the many ways in which government can harm real economic growth and wealth.
3. US Credit and Economic Views: It’s the Housing Market Stupid - Constance Hunter wisely notes the deflationary pressure of over $1 trillion in underwater mortgage debt. This remains a key aspect of my view that inflation will remain muted for several years.
4. Tuning In to Dropping Out - Alex Tabarrok draws attention to the lack of college graduates in STEM fields and the disappointing level of dropouts both in high school and college. Focusing subsidies on STEM majors and offering “vocational” programs are a couple potential solutions for improving education within the US.
5. GAO: Almost Half of Bailed Banks Repaid the Government With Money “From Other Federal Programs” - Matt Stoller examines the truth behind Treasury’s claims that “TARP made money.”
6. For Profit Education, Pigs at the Trough - Russ Winter looks at how For Profit Education programs are abusing the government system to earn massive profits, while loading students with debt and only graduating around 33%.
7. Josh’s Twenty Common Sense Investing Rules - Joshua Brown provides a great outline for individual investors, not traders.