Tag Archives: investment strategy

navigating the next twelve months (i)

June 8, 2015 By in Current Market Thoughts, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , 3 Comments

As I wrote on Friday, I think we’re at an inflection point in the US stock market.  It seems to me the market is now beginning to take seriously the idea that the Fed will soon be beginning to raise interest rates from the current near-zero.

In one sense, this is not Wall Street’s first rodeo.  There are plenty of times in the past when the Fed has been reversing emergency monetary accommodation applied during a recession.  The investment community has already sifted through them ad nauseam.

On the other hand, the extent and duration of the current monetary easing are both without precedent.  At the same time, the way the market factors new information into stock prices has changed considerably over the last decade.  The goals and risk preferences of the Baby Boom, the most powerful retail influence on stocks, have shifted as well, as that generation has aged.

Boomers are more interested in income than in capital gains.  Hedge fund managers and algorithm-fashioners seem to have very short time horizons–almost reacting to information as it hits the news media rather than anticipating it.  (I almost cringe to write this last.  It reads a lot like the criticisms made by elderly patrician money managers of the past (whom I made fun of at the time) who held stocks for decades at a time and were struggling to adjust to the faster-paced market of my early years on Wall Street.  Still, I think what I’m saying is correct.)

Therefore, I think, we can’t just blindly apply generalizations from the past to our present situations.

two types of tightening

It’s important from the outset to distinguish between two types of Fed tightening:

–restoration of the real rate of interest from negative to positive as the economy recovers from recession, and

–raising the real rate of interest substantially above inflation in order to slow down an economy that’s potentially overheating.

Today, we’re dealing with the first kind, not the second.

what the past tells us

During past periods of Fed tightening of the first type, stocks have been volatile but have generally gone sideways to up.  Bonds, on the other hand, go down.

This, in itself, has implications for stock market strategy.  Stocks that resemble bonds the most tend to do particularly badly; (at least some of) those that resemble bonds the least do the best.

More tomorrow.

 

 

the May 2015 Employment Situation

June 5, 2015 By in bond market, Constructing a Portfolio, Current Market Thoughts, Employment Situation report, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

the May Employment situation

At 8:30 am, est, this morning the Bureau of Labor Statistics of the Labor Department made its usual release of the monthly Employment Situation.  The report showed the economy added +280,000 new jobs during May, substantially higher than economists’ estimates of +225,000.  Of the total, 262,000 positions were in the private sector, 18,000 in government.

Gains in government employment are almost exactly offsetting declines in mining/oilfield.

revisions

Revisions to prior months’ estimates added another 32,000 to the tally.

Average hourly earnings were up by 2.3%, year on year, showing no acceleration from their recent tepid growth, despite the low current unemployment rate (5.5%) and the sharp employment gains.

why the report in important for investors

What I find interesting is the financial market reaction to the positive report, namely:

–S&P 500 future have declined modestly

–the US$ is up by about a percent against the euro and the yen

–gold is down a percent in dollars (flat in euros or yen)

–in pre-market trading, financials (higher interest rate beneficiaries) are doing relatively well, utilities (whose attractiveness as income vehicles is lessened by higher rates) relatively poorly.

the message

In other words, the message the market is taking from the ES is that the Fed is going to begin to raise short-term interest rates relatively soon (September?).

I think this ES most likely marks an important turning point in market psychology.  Since early 2009, investors have taken heart–and portfolio positioning cues–from the idea that interest rates were extremely unlikely to rise and might possible decline. Investors who adopted an appropriate portfolio structure have been rewarded by seeing rates fall to what were initially undreamed of low levels.

That period is over.

Now rates are highly unlikely to fall and may rise.  Although rates will doubtless rise very slowly and may reach “normal” at much lower levels than in previous economic cycles, this is an important distinction.  It implies that the market will (finally) reorient itself into anticipation of rising rates.  It doesn’t need to have a precise idea of where rates are headed.  The key thing is that the easing trend of the past seven years or so is behind us.

More on Monday.

 

 

return potential for US stocks–suppose Goldman is right?

May 28, 2015 By in bond market, Investment firms, stock market, Strategy Tags: , , , 1 Comment

Yesterday I wrote about the view of Goldman equity strategist David Kostin that, on a capital changes basis (i.e. , not counting dividends), the US stock market will be flat over the coming 12 months and will edge higher at only about a 2% annual rate for at least several years after.  Collecting dividends will be a major source of total returns.  In fact, if the reason for this sub-par showing (by historical standards) is that earnings will grow but price earnings multiples will contract as interest rates rise (I’ve only read a bare-bones summary of Mr. Kostin’s view), then dividends may be the major source of returns.

Let’s suppose Mr. Kostin is right.  What does this mean for investors?

my thoughts

1.  Losing stocks will be devastating.  Large losses always hurt more than large gains.  But a strongly rising market tends to act somewhat like a safety net to cushion the fall, as well as offering a chance to catch the next shooting star to make up for the mistake.  A flat market is less forgiving, and will presumably offer fewer chances to recoup from losses.

2.  One or two winners will probably be enough to make a portfolio manager’s year.  Careful securities analysis will be rewarded with outperformance, provided a manager can avoid having big losers.  Again, this is nothing new–although the idea that having a ton of stocks you spend only a little about is not as good a strategy as having a few you know inside out has eluded academics until recently.

3.  Trading stocks, aka market timing–a tactic reviled in investment folklore–probably becomes more important as a source of performance (maybe this is why GS is content to let Mr. Kostin publish).  This will be doubly so for non-taxable accounts.

If we truly believe the major trend is sideways, buying and selling portions of positions based on valuation–especially in the case of stable, mature companies–becomes a more attractive strategy.  This is sort of like bunting for a base hit–you need a lot of successes to score a run.  But it may be the only way to get on the board if the market is throwing blanks.

4.  For institutions, trading through derivatives–maybe in the same fashion big bond funds operate–would provide liquidity and speed that gigantic portfolios can’t get otherwise.  Custom-tailored OTC derivatives may be the most preferred.  Not for you and me, but probably for the largest money management houses.  Great for brokers’ profits, too.

 

return potential for US stocks

May 27, 2015 By in Constructing a Portfolio, Current Market Thoughts, Investment firms, stock market, Strategy Tags: , , , , , Leave a comment

Yesterday’s Wall Street Journal contains a summary of projections by Goldman equity strategist, David Kostin, for US stock market returns this year and beyond.

His view is that stocks will be flat over the coming 12 months–investors will collect dividends but no capital gains.  After that, stocks will average +5% yearly total returns for the rest of the decade, miniscule a meaning they’ll continue to collect dividends plus, on average, miniscule capital gains.

Of course, like any brokerage house, Goldman has a plethora of strategists, not just Mr. Kostin.  The ones waiting in the wings cover the waterfront from bullish to bearish with their views, so at least one is bound to be right–and can come off the bench to replace Kostin if need be.

Still, Mr. Kostin has the title, and he’s the one who makes the rounds of brokerage clients to present Goldman’s views.  So his is most likely the firm’s official position–and agrees at least  in spirit with the beliefs of Goldman’s top management.

Kostin’s is a peculiar stance for a broker, nonetheless.

In the real world, no brokerage research report is intended to be “pure” scholarship.  Yes, every document is intended to show off the firm’s deep factual knowledge and analytical skills.  But it’s also supposed to produce revenue by flattering the firm’s investment banking clients and persuading its money management customers to transact.

A bearish strategy may do the first but it certainly won’t do the second.  It won’t produce the kind of revenue a document like this is aimed at achieving.

So why publish something like this?

I can think of several reasons:

–it’s possible that Goldman figures that institutional money management clients aren’t going to generate much trading revenue from now on (the substitution of index funds for active managers?), so it no longer matters that much what the firm tells them,

–maybe Goldman senses that a pollyannaish story from, say, Senior Strategist Abby Joseph Cohen, would go down worse,

–perhaps the Kostin view is actually bullish, or at least as bullish as Goldman is willing to be.  Maybe Goldman anticipates a big stock market selloff as interest rates begin to rise and intends the idea that, given time, investors will steadily regain what they’ve lost (plus some) to stand as a beacon of hope.

–it could be that Goldman wants to sell non-traditional products to investment managers as a way of dealing with potential hard times.

More tomorrow.

cyclical growth vs. secular (ii)

May 15, 2015 By in currency markets, Recent Market Action, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

Same topic as yesterday, different starting point.

When the monetary authority begins to tighten policy by raising interest rates, it does so for two reasons:

–the domestic economy is giving signs of overheating, that is, of growing at an unsustainably high rate, and needs to be reined back in before runaway inflation results

–too much money is sloshing around in the system, and finding its way into more and more speculative investments.

For stock market investors, the tightening process implies two things:

–the rate of profit growth in business cycle-sensitive industries is peaking and will begin to decline, and

–playing the greater fool theory by holding crazily speculative investments will no longer work as excess money is siphoned out of the economy.

However the Fed proceeds, the second effect will surely happen, I believe.  But the US economy can scarcely be said to be overheating.  Despite this–and the Fed’s promised vigilance to prevent a meaningful slowdown in economic activity, I think all stocks–and cyclical ones in particular–will be affected.

Why?

…because the Fed tapping on the brakes lessens/removes the ability of investors to dream of a possible openended future cyclically driven upsurge in profit growth.  Whether specifically aimed at this or not, Fed action will have the effect of tempering Wall Street’s avaricious dreams.

What about dollar weakness, EU growth, China…?

In every cycle there are special factors.  They don’t change the overall tone of the market, though.

The main effect of a weaker dollar and stronger EU economic performance will be to increase the attractiveness of EU stocks, and of US names–principally in Staples and IT–with large EU exposure.  Look for the stocks with big holes in December and March quarterly income statements.

As for China, who knows?   My guess is that the Chinese economy won’t deteriorate further from here.  But the main China story , as I see it, will be the country’s gradual shift to consumer  demand-drive growth along with the substitution of local products for imports.  To me, both aspects suggest that well-known US, EU and Japanese China plays won’t regain their former glory.

My bottom line:  the shift from cyclical to secular may be more modest than usual this time, but it will still be there.  A more conservative mindset argues against further price earnings multiple expansion for the market.  So future market gains will depend entirely on earnings growth. The larger immediate effect will likely be in the loss of market support for very speculative stocks.