I’ve just updated Keeping Score. If you’re on the blog,you can also click the tab at the top of the page.
Archive for the 'Strategy' Category
I’ve updated Keeping Score for January 2012
Published February 3, 2012 Current Market Thoughts , Keeping Score , Portfolio management , Recent Market Action , Strategy Leave a CommentTags: business, Current Market Tactics, economy, finance, investment strategy, Keeping Score, market tactics, Portfolio management, stock market
two more years of emergency-low interest rates!
Published January 31, 2012 Current Market Thoughts , from growth to value: the life cycle , growth vs value , Recent Market Action , Shaping a portfolio for 2012 , Strategy Leave a CommentTags: bonds, business, Current Market Tactics, economy, Federal Reserve, finance, FOMC meeting, investing, investment strategy, money, stock market
the January 25th Fed meeting
Last week’s meeting of the Federal Reserve’s Open Market Committee had two important results:
1. Chairman Ben Bernanke said the Fed funds rate, which has been at effectively 0% for just over three years (since December 16, 2008–how time flies) will likely remain at or near the current low rate into 2014.
2. The Fed gave more detail than ever before on its thinking about prospects for the US economy and the appropriate level for the Fed funds rate.
The Fed thinks:
–the long-term growth rate of the US economy is +2.4%-2.5% a year (vs. 3%+ a decade ago). The agency is content, however, to allow growth at somewhat above that rate from now into 2014.
–the appropriate long-term level for the Fed funds rate is about 4.5%, which amounts to a 2.5% real rate of interest (“real” means after subtracting inflation from the nominal rate). This contrasts with the current rate, which is a negative real rate of about 2.5%.
–although the process of normalizing interest rates will probably begin before the end of 2014, the Fed is unlikely to raise the funds rate above 1% until at least 2015.
–despite the immense monetary stimulation going on now, inflation will not be an issue. It will remain at 2% or below.
–the “natural” rate of unemployment, that is, full employment, is 5.5% of the workforce (in theory, the 5.5% is friction in the system–like people in transit from one employment location to another, or who decide to take a short break between jobs…).
According to the Fed’s projections, the unemployment rate will remain above 8% until some time in 2013. It probably won’t crack below 7% for at least the next three years.
implications
The forecast itself isn’t a shocker. The Fed has been talking about slow but steady progress for the economy, with no inflation threat, for some time. The real news is that the Fed expects the current situation to persist into 2105, a year longer than it had previously indicated.
1. To my mind, the biggest implication of the Fed announcements is that it makes less sense than ever to be holding a lot of cash. How much “a lot” is depends on your economic circumstances and risk preferences. But the Fed is saying that a money market fund or bank deposit is going to yield nothing for the next two years and well under 1% for the year after that. Yes, you have secure storage in a bank and substantial assurance you won’t make a loss, but that’s about it.
To find income in liquid assets–as opposed to illiquid ones like, say, rental real estate–you have to look to riskier investments, dividend-paying stocks or long-dated bonds. That in itself is nothing new. Savers have been reallocating in this direction for the past couple of years. Last week’s Fed’s message, though, is that it’s much too early to reverse these positions. If anything–and, again, depending on personal circumstances and preferences–investors should think about allocating more away from cash.
2. When the process of normalizing interest rates is eventually underway, the yields on long-dated bonds and dividend paying stocks will be benchmarked–and judged–against cash yields of 4%+. For stocks, a static dividend yield of 3% won’t look that attractive. At some point, low payout ratios (meaning the percentage of earnings paid out in dividends) and the ability to increase cash generation will become key attributes. Both are indicators of a company’s ability to raise dividends.
3. It’s my experience that when the Fed begins to tighten, Wall Street always underestimates how much rates will rise. Last week, the Fed told us that when the Fed funds rate goes up this time, its ultimate destination is 4.5%.
4. Investors taking a top-down view, that is, looking for the strongest economies, will have to seek exposure outside the US–which will only look good vs. the EU and Japan. The main issue is demographics–an aging population. It’s probably worthwhile to try to figure out what characteristics of the latter two economies, both of which have older populations than the US, are due to social/cultural peculiarities and which are due to aging. The second set of traits may well turn up in the US market as well.
5. The mechanics of how growth stocks and value stocks work may change in a slower-growing economy. It’s hard to know today how that will play out. True growth stocks may be harder to come by. Value investors who say they buy asset value of $1.00 at $.30 and sell it at $.70 may have to buy at $.20 and sell at $.60 if there’s less room for second- and third-tier companies to succeed.
I think it’s way too soon to be worrying about anything other than #1. The rest are thoughts to be filed away for next year, maybe.
two investor sentiment surveys: straws in the wind or contrary indicators?
Published January 25, 2012 Current Market Thoughts , Recent Market Action , Strategy , Technical Analysis Leave a CommentTags: business, Current Market Tactics, economy, finance, investing, investment strategy, investor sentiment, market tactics, Portfolio management, stock market, Technical Analysis
investor sentiment
Investor sentiment is a funny indicator. Outside the US, investors try to figure out what way the tide of sentiment is flowing so they can set their portfolios to benefit from the prevailing direction. Inside the US, on the other hand, professional investors try to determine the direction of sentiment so they can bet against it.
Surveys, of course, have the limitation that they tell you what the respondents have to say. Normally secretive professionals may simply not respond, so you may end up surveying interns rather than senior managers; or they may not give their true opinions, for fear their views will be incorporated into the consensus before they are able to exploit them to the fullest.
Once you’ve set your portfolio, whether you then seek publicity for your largest holdings is a matter of personal preference or taste. I would prefer not to do so, although I don’t regard the practice as border-line unethical, as some do.
two surveys
Anyway, I’ve come across two peculiar investor sentiment surveys recently.
–The first comes from the Chartered Financial Analyst Institute. The Institute conducts a series of exams on academic portfolio theory, passing all of which results in the test-taker qualifying for a CFA charter (suitable for framing) that attests to the holder’s knowledge of the concepts. Once the province solely of professional portfolio managers and securities analysts, the current 90,000+ holders of the CFA designation are much more widely distributed through the various functions of investment-related organizations and the academic world.
Conclusions from the Global Market Sentiment Survey:
–Almost two-thirds of the 58,000 respondents to the survey expect the world economy will show no growth in 2012. 34% expect economic contraction; 29% think the world will tread water this year.
–About 60% expect that equities won’t be the highest return investment asset this year. Among the competing alternatives, precious metals gets the most votes for top-performing asset, followed by commodities, bonds and cash. Sentiment on this topic is split geographically, as well. Of investors in the Americas, 45% think equities will have the best returns in 2012; elsewhere, the proportion is only about a third.
The second survey is one conducted by a popular small-cap service I recently subscribed to. Asked what they thought the probable returns for the S&P 500 this year might be, the most frequently given answer was a loss of 20%.
the respondents
As to the second survey, I was very surprised at how negative subscriber sentiment appeared to be. I also looked at a couple of other surveys, one of which had some respondents saying small caps were too risky to invest in–yet, as subscribers, they were paying for information about small-cap stocks. I don’t know what to make of that.
The CFA survey had one remarkable characteristic. Half of the respondents had either not yet passed all the exams or had held their charter for two years or less. Another 19% had been CFAs for five years or less. These are not portfolio managers or senior analysts actually making investment decisions. They’re much closer to being the man in the street.
my thoughts
I think the relative inexperience of the CFA survey respondents means that they’re much more indicative of what the man in the street thinks than of what the “smart money” is doing. In a section about employment opportunities, over half the respondents from Europe said that the job situation has deteriorated. 39% of those in Asia Pacific said the same. So it’s also possible that the respondents have been unable to distinguish between their own career outlook and prospects for world equities. My guess is that their macroeconomic and asset market answers are contrary indicators.
The (potentially oddball) respondents to the small-cap survey? Clearly a contrary indicator, in my opinion.
All in all, two small reasons to want to be bullish.
I’ve just updated Current Market Tactics
Published January 23, 2012 Constructing a Portfolio , Current Market Thoughts , economics , Portfolio management , Recent Market Action , Shaping a portfolio for 2012 , Strategy Leave a CommentTags: Current Market Tactics, economics, economy, finance, investing, investment performance, investment strategy, market tactics, money, Portfolio management, stock market
I’ve just updated Current Market Tactics. If you’re on the blog, you can also reach the CMT page by clicking the tab at the top of the page.
prospects for fixed income in 2012 (III): conclusions
Published January 19, 2012 Constructing a Portfolio , Current Market Thoughts , Portfolio management , Recent Market Action , Shaping a portfolio for 2012 , Strategy Leave a CommentTags: Banks, bonds, business, Current Market Tactics, economy, finance, investing, investment strategy, Jamison and McCarthy Investment Advisors LLC, market tactics, money, Portfolio management, Strategy Asset Managers
This is the final installment of three that contain a bond market analysis by money manager Strategy Asset Management, LLC. (Installment I, Installment II)
Risk and Return
Bond investors will face some difficult choices in the months ahead. Our base case for 2012 includes a modest acceleration of GDP growth accompanied by an improvement in employment and personal income. US housing prices will finally stabilize and inflation, as measured by the Consumer Price Index less food and energy costs, will continue to rise. (This inflation measure bottomed at 0.6% year over year in October and now stands at 2.2%.) The Federal Reserve, however, is likely to keep short term interest rates at virtually zero. All this points to a significant rise in government bond yields.
The current yield curve for government bonds looks strikingly similar to that which prevailed at the close of 2008. Based on the improving domestic economy and our assumption that the European debt problems will be contained (admittedly, not a universally held point of view), we think the changes in bond market yields will be very similar to those which occurred in 2009. If so, it implies interest rate increases in excess of 150 basis points for US Treasury securities with maturities of five years or more. That translates into a near 12% price decline for ten year government securities. To avoid these possible losses, investors would need to shrink the average maturity of their portfolios to two years or less and accept current returns of 0.25% versus the 2%-plus yields now available on longer dated investments.
Mortgages, normally a refuge for investors in a rising rate environment, pprobably won’t be a good port of call in 2012. The market prices of high coupon mortgage securities are astronomical–GNMA pass-thru mortgages with coupons between 5% and 7% are being valued at 110% to 115% of par value. These premiums are much higher than during previous low yield episodes; for example, GNMA 7% coupons never traded above 106 until mid 2010. The current mortgage market bubble has occurred because mortgage refinance activity in these premium coupon mortgages has been exceptionally low, limiting prepayment losses for investors. Borrowers have been unable to refinance because they are underwater on their existing mortgages and lack the equity to meet requirements on new mortgages. That could all change with the stroke of a pen.
It is rumored that President Obama wants to replace the acting Federal Housing Finance Agency head with a more activist chairman and push for a multi-trillion dollar refinancing plan. It would permit current borrowers in the government agency guaranteed programs to refinance into lower coupon mortgages with no requirements other than being current on the existing mortgage. No appraisals, no income verification, no upfront payments. This is actually a great idea. It would save consumers tens of billions of dollars a year, increase housing demand and lift home prices, and boost economic growth–in an election year no less. The losers under the plan would be holders of high coupon mortgage securities who would probably see the market value of their investments drop at least 5%.
While a change in the rules could hurt high coupon mortgages, their lower coupon cousins–the mortgage pass through securities with 3.5% to 4.5% coupons–would be crushed if interest rates rise. Given the already inflated prices of even these securities, their upside appreciation potential, even in a declining interest rate environment is very limited. (And we could see that further reduced if government actions unleash a flood of new low coupon securities.) Meanwhile, they would suffer sizeable price declines and negative total returns if interest rates rise.
Making choices
As we begin 2012, most of our accounts are 20% to 30% below their benchmark maturity targets. This is at the outer end of our usual duration bands and represents a significant call on the direction of interest rates. During the fourth quarter of 2011, we added to our holdings of short term US Treasury notes. We are generally overweight US Treasury securities compared with mortgages. Nonetheless, a large rise in market yields would result in losses for most of our portfolios. Accordingly, it is possible in the months ahead we may adopt an even more defensive maturity stance if the economic and political scenario we envision begins to materialize.
In closing, we thank you, our clients, for your support during 2011 and we will continue to work to merit your loyalty in the year ahead. We wish you a healthy and prosperous New Year.
Note: The Market Environment reflects the vies of the Investment Advisor only through the date of this report. The Investment Advisor’s views are subject to change at any time based on market and other conditions. December 31, 2011.
Thanks again to Strategy Asset Managers for allowing PSI to publish “Bond Market Environment, Fourth Quarter 2011.”
