odds and ends

talking directly with customers

Before the financial crisis, equity portfolio managers rarely talked directly with retail customers.  The central marketing concept was to create “third-party endorsements” by appearing on financial television programs.  Oddly, in my view, but I’m confident it’s correct, retail clients were more powerfully convinced to invest by a portfolio manager’s appearance on CNBC than by a fundamentally sound approach, a strong analytic staff and a long record of outperformance,

That strategy no longer works.  I’m not sure about the dynamics, but in today’s world the talking heads fancy themselves to be the real experts, even though few if any have ever been professional investors and they all by and large spout nonsense as far as I can see–entertaining nonsense, but still nonsense.

What I find interesting about the current market decline is that I’m seeing mutual fund and ETF providers conducting online presentations/client meetings with their fund holders.  I think this makes a lot of sense.  It may turn out to be one of the (many, I think) fundamental business changes that occur as a result of our current unusual circumstances.

 

reading stock prices

When I started my second job as a portfolio manager, Australia was the area I was responsible for.  Every morning my boss would call me into her office and grill me about the course of the market overnight.  She would say a ticker symbol.  I had to tell her the high/low/close; the volume if it was unusual; the brokers (and clients, if possible) most involved; and whether or not the movement was in line with other names in the relevant industry or not.  If not, why not.

It was pretty awful.  And the practice lasted until I knew more than she did about what was going on.  But I learned a valuable lesson–that many times the prices talk.

The US market is big enough that no one can listen to all the prices. But I think there are times when the prices are unusually informative.  This is one of them, in my view.  What I see is that the market is trying to separate post-pandemic winners from losers.  My read is that weak stocks now are expressing the market’s first pass at what will continue to be weak from here on.

 

market cliché of the day

The cliché:  when the market recovers from a serious decline, the old leadership is left by the wayside and new leadership emerges.

The “old” leadership is multinational firms without extensive manufacturing located in the US, tech and especially software, in particular.

Will this happen now?  My guess is no.

 

double bottom?

That’s the way it usually works.  The market bottoms the first time (the consensus seems to be forming that that’s what’s happening now) at the time of the utmost bad news.  It then rises for six weeks or so   …before returning to “confirm” the bottom by touching the former low, or maybe a tad lower, before motoring ahead for good.

I’ve written about this process now and again, including just recently.  But I’ve heard and read so many predictions of a double bottom–“don’t buy now, wait for the second bottom”–that I’m beginning to think that won’t happen this time.  I have no idea, though, what might take its place.

 

 

 

 

the Dow Jones Industrial (DJI) average

Despite its media ubiquity and the fact it has survived all these years, the DJI is a weird index:

–it contains only 30 names out of the thousands of publicly traded companies

–although the index owners have tried to make it more relevant in recent years by adding Apple, Microsoft and Nike, it still by and large represents the big-cap names of America’s yesterday

–the weighting of a given name is a function of its per share stock price, not the size of the company.  As a result, Microsoft counts less than Visa, despite being 3x V’s size.  MSFT is about 1200% the size of IBM, but has only a third more weight (stock price of 150 vs 110).  While the ease of calculation this brings might have been important in the pre-computer age, it’s an anachronism now

–because of all this, using the DJI is a convenient signal to the listener that a speaker knows very little about stocks.  Odd that it should be used by media stock “experts”   …or maybe not.

 

Pre-APPL, MSFT, NKE, the DJI did have one important use.  When it started to outperform, that meant that a rally was near its end (and portfolio managers were buying the least interesting, but cheapest stocks) or that pms were seeking the safety of large, mature companies.  The additions above have lessened that appeal.

However, in the current climate, the DJI is an interesting collection of coronavirus losers.

Year-to-date, as of the close on Monday, the Dow was down by 35%, the S&P 500 by 30%, NASDAQ by 24%.  Since then, the DJI has been by far the best performer.  Interestingly, the Russell 2000, which measures mid-cap US, was down by 40% on Monday and has bounced by about 8% since, tying it with the NASDAQ for smallest bounce.

Two days isn’t much to go on, but one read is the market thinks the bailout will mostly benefit the large old-guard industrials.  A caveat:  the 57% rise in Boeing over the past two days accounts for two percentage points of the DJI rise.

 

 

 

a bear market in time? sort of…

In the middle of a garden-variety bear market–i.e., one orchestrated by the Fed to stop the economy from running too hot–I remember a prominent strategist saying she thought the market had fallen far enough to be already discounting the slowdown in profits but that the signs of recovery were yet to be seen.  So, she said, we were in a bear market in time.

We’re in a different situation today, though:

–most importantly, we don’t know for sure how much damage the coronavirus will do, only that it’s bad and we unfortunately have someone of frightening incompetence at the helm  (think:  the Knicks on steroids) who continues to make the situation worse (while claiming we’re in the playoffs)

–with most of the seasoned investment professionals fired in the aftermath of the financial crisis, and replaced by AI and talking heads, it’s hard to gauge what’s driving day-to-day market moves

–if we assume that the US economy is 70% consumption and that this drops by 20% in the June quarter, then COVID-19 will reduce GDP by 14% for those three months.  This is a far steeper and deeper drop than most of us have ever seen before

–on the other hand, I think it’s reasonable to guess that the worst of the pandemic will be behind us by mid-year and that people released from quarantine will go back to living the same lives they did before they locked themselves up.

 

It seems to me, the key question for  us as investors is how to navigate the next three months.  In a pre-2008 market what would happen would be that in, say, six or eight weeks, companies would be seeing the first signs that the worst was past.  That might come with more foot traffic in stores or the hectic pace of online orders for basic necessities beginning to slow.

Astute analysts would detect these little signs, write reports and savvy portfolio managers reading them would begin to become more aggressive in their portfolio composition and in the prices they were willing to pay for stocks.

 

How the market will play out in today’s world is an open question.  AI seem to act much more dramatically and erratically than humans, but to wait for newsfeeds for stop/go signals.  (My guess is that the bottom for the market ends up lower than history would predict and comes closer to June.  At the same time as the market starts to rise again, it will rotate toward the sectors that have been hurt the worst.  Am I willing to act on this?   –on the first part, no; on the second part, looking at hotels, restaurants…when the time comes, yes)

A wild card:  Mr. Trump now seems to be indicating he will end quarantine earlier than medical experts say is safe.  At the very least, this will likely bring him into conflict with the governors of states, like NY, NJ and CA, who have been leading efforts to fight the pandemic.  At the worst, it will prolong and intensify the virus effects in areas that follow his direction.  Scary.

 

 

 

an epic week: VIX and redemptions

I submitted a rough cut of my video to SVA last Wednesday and have been whittling down the huge pile of unread Financial Times newspapers in my kitchen.

An aside:  I get the digital FT, too.  But if for an investor the idea is to find out stuff other people don’t know yet, then what you should look for are the short articles on the back pages of the paper–not curation by what’s trending.

Two items stand out to me so far;  VIX readings and mutual fund/ETF redemptions.

VIX

The VIX is an index that tries to measure fear and greed in the stock market by, in my crayon-like understanding, calculating how much the price of puts on S&P 500 stocks exceeds theoretical value (using something like Black-Scholes, something borrowed from the physics of Brownian motion) and dividing that number by the amount that calls exceed their theoretical value.  The methodology was changed somewhat in 2003(?) and I can’t find a clear description of the new one.

People use the VIX as a gauge of market fear, on the idea that when investors are scared the premium on puts goes up and/or the premium on calls goes down.  The all-time high for the VIX  was around 150, posted 4x during the stock market decline of late 1987 (these are new VIX numbers, not those actually posted, which are much lower).  The figures we’re putting up now are the next highest.

In really bad times since then, the VIX has surged above the 40 line.  Last Wednesday it cracked through 80.  There are legitimate questions as to whether the VIX is really the Fear Gauge it is presented as being on stock market programs.  Whatever the case, it indicates market turmoil.

For us as investors, the VIX is important, on the idea that maximum panic by sellers indicates a turning point in the market.  How so?  Sellers either run out of stuff to liquidate or they faint at their desks.  Either way, selling stops.

 

redemptions

There has been a general drift over at least the last decade in the mutual fund/ETF business away from equity funds and into bond funds.  Over the past three weeks or so, however, there has been a huge surge in bond fund redemptions.  According to the FT, for the week ending last Wednesday, investors yanked $109 billion from fixed income funds (a record high), compared with $20 billion taken out of equity products.  A fraction of the money is finding its way into money market funds.  As for the rest, bank accounts?

Again, redemptions of stock mutual funds/ETFs are generally another decent fear gauge.  Bond redemptions are unusual, though, since, in theory at least, as the Baby Boom ages it gravitates more and more to bonds.

Two factors cut against this idea in the present case.  The yield on the stock market is way higher than the yield on bonds.  Maybe more important is the fear, justified or not, that the coronavirus will force fixed-income issuers to default on their obligations.

 

 

 

 

 

 

 

 

selectively bearish vs. crazy

Today’s US stock market has, at least as I’m writing this at 11AM, a much different tone than yesterday’s.  Yes, it may be disappointing that there hasn’t been a bigger bounce so far back from yesterday’s mauling.  But at least there seems to me to be a lot more selectivity to what’s being bought and sold.  The losers appear to be companies directly affected by the consumer quarantine, the winners the least consumer-facing.

A second pattern continues, though, that trading is being driven, among the losers at least, by reaction to media headlines rather than investor forethought.

 

For me, one of the more puzzling aspects of the US market throughout my professional career has been the fact that virtually no institutional money managers ever beat their benchmark index.  If, ex broker fees and commissions, investing is a zero sum game, there must be winners (who don’t disclose their results) to offset the highly visible losers.  It could be that the fees and commissions are the reason, but the extent of the professional losses seems to me to be too high.  This leaves private individuals.

I mention this because the reports I’ve read indicate individuals are buying as institutions are forced to sell to meet investor withdrawals.

is America great again?

stocks and economic forecasting

Historically the stock market has been the most reliable of the leading indicators of future US economy performance, turning up and down roughly six months ahead of domestic economic data.

The three main factors I see in making this so are:

–stock buyers have traditionally tried to look forward to anticipate future earnings performance, while the bond market has been more focused on the here and now;

–as financial instruments, stocks are sensitive to changes in Fed policy aimed at either accelerating or reining in the economy

–until the financial crisis, legions of veteran securities analysts collected and processed economic information that began to be factored into stock prices long before the data became public knowledge.

It’s not clear to me that this continues to be true, given that veteran researchers have all but disappeared on Wall Street, and that the characteristics of their AI replacements aren’t well know.

With that caveat, now that I’m trapped in the house and am trying to avoid compiling a bibliography for my thesis paper, however, I’m finding time to fool around with numbers and to blog.

stocks under Trump

Since the 2016 election (the numbers since inauguration are lower), the NASDAQ index is up by about 40%.

The S&P 500 has gained 35%+.

The Russell 2000, which is much more representative of domestic US businesses, is down by about 10%.

As a citizen, I think that the Russell 2000 wants better schools, better infrastructure and retraining for workers displaced by technological shifts.  Stock prices seem to indicate not enough of that is happening.

 

 

bonds vs. bank loans: drawing down your revolver

 

A number of transport companies announced this morning that they are drawing down their revolving likes of credit with banks.  What does this mean?

bonds vs. bank loans

Bonds are fixed income instruments sold to investors.  Although, like everything else in financial markets there are myriad variations, a plain-vanilla bond is a fixed term and a fixed interest rate borrowing.  Absent the issuer violating loan covenants, holders can only get their money back before redemption date by selling the bond to someone else.  And in recent years of low yields, strong covenants have been few and far between.

Bank loans are a different animal.  For one thing, the counterparty is a bank or group of banks.  Some bank loans are fixed-term, typically with covenants that have more teeth.  Revolving lines of credit, or revolvers, in contrast, are the corporate equivalent of credit cards.  Lines can be borrowed or repaid at will and are very often used for seasonal working capital needs.

The key difference in today’s world:  a bank credit committee periodically reviews the revolver lines to make sure they’re appropriate.  I’ve seen instances, though, where the bank calls an ad hoc credit committee meeting and yanks the line because of changing economic circumstances.

why this matters

This is what I’m reading in today’s news–transport companies are afraid their credit lines will be withdrawn and are grabbing the money before banks can act.