The Vanishing Treasury Yield

Thursday, August 2nd, 2012

by Neuberger Berman Research

July 2012 – Investment Strategy Group

Despite hitting record lows earlier in the year, the yields on U.S. Treasury bonds continue to tumble. The 10-year rate ended last month at 1.62%, materially below the long-time monthly record low of 1.95% set in January 1941. Yields for 10-year Treasury Inflation-Protected Securities (TIPS) have been persistently negative since the fourth quarter of 2011 and continue to trend lower, implying that investors are paying increasingly higher prices for the relative safety these investments are supposed to provide. In this edition of Strategic Spotlight, we consider why yields continue to decline and the implications for investors.

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A Mystery, But Is It?
Yields on long-term Treasuries have been declining since the 1980s, when they peaked along with inflation. Since the financial crisis of 2008, the continued reduction in Treasury yields has at times perplexed even the most astute investors. One prominent bond guru famously avoided them in 2010 to the detriment of his portfolio, and pundits who prematurely declared the imminent “death” of bonds couldn’t have been more wrong. In recent years, yields have moved even lower even though inflation has held fairly steady.

Over the longer term, nominal yields for long-term Treasuries generally follow inflation levels and growth expectations. When inflation rises, nominal yields typically rise to compensate for the erosion in purchasing power and, similarly, if growth expectations rise, the increase in attractive investment opportunities in the economy tends to result in rising real (after inflation) interest rates (see Figure 1). Oddly enough, inflation expectations (as implied by the difference between the nominal 10-year Treasury yield and TIPS yield) have held steady at around 2% and the decline in nominal rates has been driven mostly by declining real yields—all in the face of a positive, albeit slow, growth environment.

REAL YIELDS AND GDP TEND TO MOVE TOGETHER

Source: Factset.

So, what explains this somewhat unusual phenomenon? Since the onset of the financial crisis, bond purchases by the Federal Reserve have increased as it has implemented unconventional monetary policies, specifically quantitative easing and maturity extension programs (known to most as Operation Twist). Through these measures, which have tended to lower long-term interest rates, the Fed has sought to stimulate the economy and reduce unemployment at a time of low inflation. Another pressure on rates has come from foreign demand for Treasuries, which has generally been very strong, especially during periods of heightened market anxiety. In recent months, slowing purchases by emerging market central banks have been offset by flight-to-quality demand from European investors, who have also driven the nominal rates on certain German, Dutch and Danish bonds to negative levels. Meanwhile, U.S. investors have shown a lack of appetite for risk as flows to bond mutual funds have outpaced those into equities.

How Low Can Rates Go?

In theory, there is no bottom for bond yields. Declining inflation and continued risk aversion have historically caused nominal rates to fall. Real yields have been significantly negative in certain time periods, although admittedly when inflation was higher than today. Figure 2 shows that there have been two key periods since the 1920s in which real rates where very negative—during the Great Depression and World War II era, and in the 1970s when inflation spiked along with oil prices. Should global economies falter in the coming months, it’s possible that interest rates could move In theory, there is no bottom for bond yields. Real yields have even been significantly negative in certain time periods. lower (even turning negative on the short end), especially if the Fed engages in another round of asset purchases.

REAL RATES HAVE ‘GONE NEGATIVE’ IN THE PAST

Source: Factset.

Better Opportunities Elsewhere

It should be noted, however, that there are major risks in holding Treasuries with little to no yield. An end to the continued bull run in Treasuries would imply a reversal of some factors supporting it now, such as low inflation, deteriorating growth expectations and worsening prospects for the eurozone debt crisis. With global central banks launching unprecedented levels of monetary easing, potentially higher levels of inflation could hamstring the Fed’s ability to continue asset purchases – causing both inflation expectations and real yields to go higher. In addition, investors may realize that Treasuries might not be as “risk-free” as they assumed, particularly as the debate over the U.S. federal budget deficit intensifies later this year.

While interest rates could still move lower in the short term, we believe that the return profile for the asset class is skewed to the downside, especially given our base-case assumption of low but positive growth. We advise caution in holding excess levels of Treasuries and believe that other assets, such as high yield fixed income and high-quality U.S. equities, could be more attractive in this environment. Similar to buying tech stocks in the late 1990s with no sales and earnings, buying today’s Treasuries with minimal yields could prove hazardous for investors.

*Source: Factset

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Secular Outlook: Implications for Investors

Monday, July 30th, 2012

by William R. Benz, PIMCO

• For investors, the biggest challenge now is moving from a world of normal distributions, with expected occurrences around the mean, to one of bi-modal distributions where more extreme scenarios prevail.
• Key institutions, including governments and central banks, were previously stabilising forces but are now helping to accelerate underlying, destabilising trends in the global economy and financial markets.
• In this environment, investors need to invest for outcomes rather than simply for beta and diversification.

Perhaps the most important tradition at PIMCO is our annual Secular Forum in May. Since I joined 26 years ago and participated in my first forum with 16 other investment professionals, our forums have become much bigger and much more global. More than 300 of us descended on Newport Beach or tuned in via video in our most recent round. But the tradition continues, as does the intensity and excitement, with the output of our forum – our three- to five-year secular outlook – forming the cornerstone of both our longer-term investment strategy and our business positioning.

Mohamed El-Erian, our CEO and co-CIO, in his Secular Outlook commentary “Policy Confusions & Inflection Points,” summarized three themes that we expect to play out over the next few years: continued policy and political confusion, overly incremental public and private sector responses and, therefore, greater potential for inflection points. Mohamed also discussed the key investment implications of our outlook, noting that the strategies and guidelines that may have served investors in the past will likely be challenged in the context of inflection dynamics.

That point is worth revisiting and expanding upon because, in our view, investing is fundamentally changing. Previously, most investors simply aimed to beat their benchmarks and diversify among assets to mitigate risk. But today, as we face unusual uncertainty in the global economy and the financial markets, extreme events are not only possible but increasingly likely, and in this environment, we believe investors need to define their objectives and choose strategies that target specific outcomes.

Investors’ biggest challenge

The world is facing a number of very significant challenges for which there are no easy solutions. The eurozone faces high debt levels, a lack of structural growth and pressure to get the policy mix right to avoid contagion. The U.S. is suffering slow growth, high debt, a looming fiscal cliff and political polarisation. While enjoying higher relative growth, China and the developing world are also slowing and making difficult transitions from export-led to consumer-driven ‘emerged’ economies. And globally, a lack of policy coordination, increased income inequality and the growing use of social networks as communication tools also present long-term challenges.

Uncertainty is one common theme, and another is the potential for more extreme outcomes, good or bad. The eurozone, for instance, has to either find a path toward fiscal union or create a mechanism for orderly exit, with very little room to manoeuvre in between. Likewise, the U.S. needs to find a way to resolve its fiscal issues or face the consequences of a further downgrade and eventual loss of reserve currency status.

For investors, then, the biggest challenge is not continued volatility; that’s almost a given. The challenge is moving from a world of normal distributions, with expected occurrences around the mean, to one of bi-modal distributions where more extreme scenarios prevail.

Key institutions: once stabilisers, now accelerants

In the old normal, key institutions acted as stabilisers: They generally behaved in a counter-cyclical fashion to help enforce reversion to the mean. For example, governments and central banks enacted policies to stimulate growth and prevent deflation during economic downturns and did the opposite in upturns. Regulators tended to de-regulate during tough times and tighten the rules during times of excess, while financial institutions decreased and increased lending as interest rates rose and fell.

Their actions, individually and collectively, helped bring economic growth and the markets back to normal, back to long-term averages, back to the mean. They weren’t necessarily coordinated, but they were generally effective and helped create the Great Moderation of steady growth, strong returns and relatively low volatility that we witnessed from the mid-to-late 1980s until the global financial crisis in 2008.

But today, these institutions are acting as accelerants. Governments in Europe, the U.S. and Japan are under pressure to pursue fiscal austerity rather than stimulate growth, exacerbating the downturn. Central banks are largely going their own way, after a well-coordinated response to the financial crisis, and in some cases, are resisting stimulative measures, which is slowing, if not preventing, the healing process. Regulators, adopting a ‘never again’ mentality, are creating blunt instruments to solve complex problems, leading to unintended consequences, particularly in the banking sector, at a time when more rather than less lending should be the recommended medicine. And banks, especially in the eurozone, have been severely impacted by their holdings of sovereign debt, which, in turn, has led to a vicious cycle of falling share prices, credit rating downgrades, asset sales, reduced lending, slowing local economies, worsening government balance sheets and ultimately, an acceleration of, rather than a counterbalance to, the crisis.

Finally, investors are also acting as accelerants. Individual investors have always been more momentum-driven but had little aggregate impact on markets in the past due to their small size, lack of timely and direct access to information and lack of coordinated activity. But as they’ve grown in size and sophistication, accessing real-time information through their defined contribution plans, global platforms, multi-national distributors, private banks and independent financial advisors, their impact has become much more pronounced. When risk sectors outperform, flows into those sectors tend to increase; when they underperform, flows tend to diminish. In both cases, underlying trends are reinforced.

What’s even more interesting is how the behaviour of institutional investors has changed. This began in 2000-01, after the technology bubble burst. The perfect storm of plunging equity markets and falling interest rates turned corporate and public pension plan surpluses into deficits and created big challenges for foundations, endowments and others seeking income and targeting specific absolute returns. The movement toward solution-based investing was born as investors began to shift toward liability-driven investing (LDI), absolute return, income seeking and other, more specific strategies. The momentum increased following Lehman’s bankruptcy and again in response to recent events in Europe. But with this shift has come a more activist (or re-activist) approach, as investors make larger and more frequent changes to overall strategy, tactical weightings, benchmarks and guidelines. Some still prefer to rebalance around their longer-term, normal policy targets, but as a group – and we see this globally across our client base – institutional investors have indeed become more active.

Governments, central banks, regulators, financial institutions and investors – each group is responding to the challenges they are facing in a logical and well-intentioned fashion. Yet in the current secular environment, we believe their actions are adding to, rather than smoothing, volatility. And instead of acting as stabilising forces, we believe they are actually helping to accelerate the underlying destabilising trends. (See figure below.)

Significant implications for investors

Global challenges combined with these market accelerants have created an environment of unusual uncertainty in which ‘muddle-through’ is a temporary state. We believe this has significant implications for investors, particularly those who are still investing simply for beta and diversification rather than for specific outcomes.

First and foremost, the new normal is here, and investors need to embrace it. We coined the phrase a few years ago to describe a multi-speed world on a bumpy journey of deleveraging, reregulation and eventual reflation. We can argue whether we’re still on the journey or we’ve arrived at the final (though still very bumpy) destination. But what’s clear is that what felt like a ‘new’ normal back then now just feels normal. Gone are the days of the Great Moderation, reversion to the mean and normal-shaped distributions, in our view; instead, continued (high) volatility, acceleration in trends and bi-modal outcomes have become the new norm. In an era when muddle-through is no longer a viable option – for Europe, the U.S. and potentially others – investors need to rethink their overall approach and brace for more extreme economic and market events.

Second, there is no free lunch. There never really was, but investors are facing even more difficult trade-offs today. If the objective is to enhance yield or upside potential through credit, high yield, emerging markets, equities or other risk sectors, the likely trade-offs in a bi-modal world are higher volatility and greater downside. If the goal instead is to own ‘safe haven’ assets for downside risk mitigation, such as U.S. Treasuries, U.K. gilts or German bunds, the trade-off is currently negative real yields. And if the need is to maximise liquidity through cash instruments, the payoff is truly negative real yields (with negative nominal yields on occasion). Even when seeking inflation protection, whether through inflation-linked bonds or hard assets – like gold, real estate and commodities – we believe the trade-offs in terms of real yields, volatility and downside risk are much less attractive in this environment.

Third, investors need to think differently with respect to allocations, benchmarks and guidelines. We’ve highlighted this in the past, but it’s even more important today. In our view, asset allocation should be risk-factor-based as bi-modal distributions and accelerants are not friendly toward traditional mean-variance methodologies, which aim to maximize returns for given levels of risk. Benchmarks should be GDP- rather than market value-weighted, particularly in fixed income space, to reduce exposure to those countries, sectors and issuers with the highest or fastest growing debt. And guidelines should be flexible, with more rather than less discretion, so as to allow managers to play both offence and defence in a bi-modal world.

Fourth, investors should be confident in their managers’ ability to understand and measure risk. Global challenges, market accelerants and unusual uncertainty put a premium on risk management. This includes understanding how the credit sensitivity of fixed income investments can affect their duration – i.e., ‘hard’ versus ‘soft’ duration – and help determine what is considered a ‘safe haven’ and what isn’t. It means performing credit analysis of sovereigns knowing they have more than just interest rate risk. It necessitates analysing the entire spectrum of the capital structure to pinpoint exact needs in terms of collateral, covenants and other forms of defence. Derivatives continue to be useful tools, but being able to identify and control counterparty risk is increasingly important. And leverage, while appropriate in certain circumstances, needs to be well understood. Bottom line: we believe in developing multiple risk measures and stress testing often.

Finally, investors need to develop specific objectives and invest for outcomes rather than simply for beta and diversification. Many investors traditionally started with risk/return targets and used historical mean-variance analysis as a framework to determine asset allocations across multiple asset classes, with benchmarks for each asset class and sub-category, and then found managers that aimed to provide returns above their benchmarks. In the days of normal-shaped distributions and reversion to the mean, this was a widely accepted strategy: Long-term realised returns and volatility came in largely as expected, and further diversification – across asset classes, within asset classes and across different managers and styles – helped to smooth short-term swings. It was a beta-driven strategy, aided by diversification. But the world has changed, and we believe investors need to deepen their understanding of their objectives and invest for outcomes.

Setting objectives and investing for outcomes

Every investor has a unique set of needs and circumstances that should form the basis for setting investment objectives. Yet it’s important to consider the secular context as well, particularly given the challenges and trade-offs we’re likely to face:

• Prolonged period of low real yields on high-quality assets, with negative real yields on traditional ‘safe havens’
• Increased potential for low and even negative real returns
• Continued high volatility with increased likelihood of bi-modal outcomes
• Eventual, though uneven, inflation pressures

Income-oriented investors should consider emphasizing high-quality fixed income spread sectors, such as covered bonds, mortgage- and asset-backed securities, investment grade credit and, depending on risk tolerance, upper-tier emerging market and high yield issues and higher dividend-paying equities.

Investors with specific return objectives should consider focusing more on absolute return strategies, ranging from unlevered LIBOR-plus approaches – essentially seeking to outperform cash – to alternative strategies, depending on their risk/return targets and liquidity needs. Credit, emerging markets, equities and other asset classes can also play roles, individually or grouped into a multi-asset approach, as long as risk factors and exposures are well understood and investors consider ways to potentially limit downside risk under more extreme ‘left tail’ scenarios.

Investors concerned with volatility and ‘fat tail’ events should consider risk-mitigating strategies. If investors want to defend against downside, potential strategies would include positions in hard-duration, ‘safe-haven’ assets, explicit tail-risk hedges or a combination. Investors focused on liabilities may want a liability-matching or LDI program. Alternatively, if the goal is to maximise liquidity, cash and short-term strategies would likely play a significant role.

Lastly, for investors worried about reflation, the suggested focus is on potential inflation hedges, such as inflation-linked bonds, commodities and real estate.

In truth, many investors will likely want to employ more than one approach – income with an inflation-hedging component, absolute return with tail-risk hedges, LDI programs that include a combination of derivative-based overlays with LIBOR-plus strategies on the underlying collateral, or any of these with a cash buffer that can be used for liquidity or to invest tactically if the opportunity arises. And this makes sense. In our view, as long as investors focus on their objectives and their targeted outcomes, rather than fall into the old ‘invest for beta and diversification’ trap, they can navigate a world of secular challenges, accelerants and unusual uncertainty.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Covered bonds are generally affected by changing interest rates and credit spread; there is no guarantee that covered bonds will be free from counterparty default. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Absolute return portfolios may not necessarily fully participate in strong (positive) market rallies. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Certain U.S. Government securities are backed by the full faith of the government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Dividends are not guaranteed and are subject to change and/or elimination. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Tail risk hedging may involve entering into financial derivatives that are expected to increase in value during the occurrence of tail events. Investing in a tail event instrument could lose all or a portion of its value even in a period of severe market stress. A tail event is unpredictable; therefore, investments in instruments tied to the occurrence of a tail event are speculative. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans. It is not possible to invest directly in an unmanaged index.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

©2012, PIMCO.

Tags: Benchmarks, Central Banks, Confusions, Cornerstone, Diversification, Financial Markets, First Forum, Global Economy, Inflection Points, Investment Implications, Investment Professionals, Investment Strategy, Mohamed, Newport Beach, Normal Distributions, Occurrences, PIMCO, Political Confusion, Private Sector, Term Investment
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Guest Post: Major Sell Signal Triggered

Wednesday, July 25th, 2012

by Lance Roberts, Street Talk Live

For some time now we have been warning about the danger to portfolios given the deteriorating fundamental, economic and technical backdrop in the markets.  Our warnings, for the most part, have been ignored as individuals continue to chase stocks in hopes that “this time will be different”, and somehow, stocks will continue to ramp higher even though all three support legs are weakening.  Currently, it is the imminent arrival of the next round of Quantitative Easing (QE) that keeps “hope” elevated but further Central Bank intervention is unlikely in the near term leaving the markets at risk of a further correction.

My job is to analyze the trend of the data, both economic, fundamental and technical, to build a frame work of possibilities and probabilities about what might happen soon.  Like any good poker player before making a “bet,” which requires putting my capital at risk of loss, I want to make sure that the odds are in my favor of winning.  If I am highly confident of success – I bet a lot.  If not – I do not.  The same philosophy goes into managing money.  Wall Street tells you to be invested all the time because that is how they make money.  However, the reality is that investing is very akin to playing poker – you are making bets today based on the possibilities of some future outcome.

The reason for this framework is that I have been negative on the markets since early April.  The weight of evidence has clearly been negative.  While the mainstream media continues to look for glimmers of “hope” – hope is not an effective investment strategy.  However, when the flow of data changes and price action becomes more constructive – my outlook will also. (Read “Thoughts On Long Term Investing”)

For new readers, welcome to the site, here is a brief compendium of previous articles which have been guiding our readers through the current market correction process that began in early April:

• April 9th – The Correction Has Started
• May 21st – Sell Signal Confirmed – Initial Targets Set
• June 6th – Forecasting The Rebound And Bottom
• June 26th – June Rally Complete – Summer Sell Off Ahead?
• July 3rd – Coming This Fall The Best Time To Invest

Major Sell Signal Is In

This bit of history leads us to our latest, and most important, sell signal to date.  With the economy continuing to weaken, corporate earnings, showing severe signs of strain and the Eurocrisis emerging once again – the risk at the moment is clearly to the downside.  The continued deterioration, in both the fundamental and technical frameworks, has significantly increased the risk of further equity market declines. 

The decline in the markets on July 24th pushed the two main moving averages that we follow into negative territory initiating a major SELL signal for the markets.  These major sell signals should not be ignored.  The first chart plots our two moving averages relative to the S&P 500 over the last 12 years.  During this time frame there has only been 7 “sell” and 6 “buy” signals.  As with all investment strategies and disciplines there is always the possibility of getting a false signal.  The same is true for this particular indicator.  Since 1930, there have been a total of 51 major “sell” signals of which 9 gave a false reading translating into a 17.6% failure rate.  As I said, no indicator is perfect, but as an investment manager I am willing to make investment decisions based on an indicator that has an 82% success rate.

More importantly, as shown in the chart, this strategy helped us avoid the bulk of the last two recessionary market debacles.  The problem is that while it is easy to assume that the current correction could be shallow, like previous two summers as the Federal Reserve stepped in to prop up asset prices, there is always a chance that it could be a much bigger correction.  Following the signals previously would have limited downside risk while keeping you primarily invested in for the majority of bullish trends.

The next chart shows the similarities of the 2011 and 2012 markets.  In both cases rallies in June, post a May decline, led to sloppy sideways trading in July.  The major “Sell” signal occurred on August 5th of 2011 as the markets began a steep sell off.  While there is no guarantee that the market is about to plunge towards the 1200-1250 level this August – the striking similarities of market action certainly does suggest a more cautionary stance be taken.

Sell Into The Bounce

Technical signals must be put into “context” based on current market conditions. In order to strip out the “noise” in our analysis we use weekly instead of daily price data.  This smoothing of the daily data allows for better clarity of the trends in the market.   However, due to this smoothing process by the time a signal is given the markets are generally overbought, or oversold, on a daily basis and are generally close for a reflexive bounce.  That bounce should be sold into.

The problem for most investors is that when the market bounces in order to correct the short term oversold condition they assume that the “sell signal” was incorrect.  More than 80% of the time, as our data shows, the market will bounce and then decline to lower levels.  Therefore, the rules are simple:

• In negative trending markets – sell rallies.
• In positive trending markets – buy dips.

The technical and fundamental setup is currently a negatively trending market.  It is very likely that, in the current environment, we will retest the May lows, if not ultimately set new lows, in August.  Those lows will likely coincide with further weakness in the economy which should be the perfect setup for the Fed to launch a third round of Quantitative Easing.  Should that occur that will provide the best opportunity to take the cash we are holding in reserve and increase equity exposure at lower price levels.

The caveat to all of this is if the Fed acts early with QE 3 at the end of this month.  I don’t think this is likely but it is a possibility.  In that event the boost to asset prices will reverse the current signal and we will need to add equity exposure back into portfolios.  However, until then, with the major “sell” signal in place it is more important to remain cautious, and conserve investment capital, until a better risk/reward opportunity presents itself.

Tags: April April, Backdrop, Bet, Central Bank Intervention, Current Market, Data Changes, Frame Work, Glimmers, Hope Hope, Imminent Arrival, Investment Strategy, Lance Roberts, Mainstream Media, Managing Money, Playing Poker, Poker Player, Probabilities, Qe, Support Legs, Term Investing
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Anatomy of a Bear (Hussman)

Monday, July 2nd, 2012

by John Hussman, Hussman Funds

In the first week of March, the U.S. stock market established a set of conditions placing it among the most negative 2.5% of historical observations (see Warning: A New Who’s Who of Awful Times to Invest) – a short list that includes the major peaks of 1972-73, 1987, 2000, and 2007. Since then, we’ve seen an increasing set of indicator syndromes that are associated with historically hostile market outcomes, maintaining us in a hard-defensive stance that is as rare as it is imperative. Last week, the market reconfirmed the “exhaustion syndrome” that I discussed several months ago (see Goat Rodeo). Prior to 2012, there were 112 weeks in post-war U.S. data where our investment strategy would have encouraged a similarly defensive position with that syndrome in place. Following those instances, the S&P 500 plunged at an average annual rate of -47.5%.

The trend-following components of our market action measures remain negative here, but it is important to note that those components are moderately – probably a small number of positive weeks – away from an improvement that could shift us from such a tightly defensive stance. While our outlook would not become bullish by any means, this shift would rein in the “staggered strike” put option hedges we presently hold in Strategic Growth. These positions (which raise the strike prices on the long-put portion of our hedges) substantially improve performance during market plunges, but make us vulnerable to the loss of put option premium during “risk on” advances such as we saw last week. That is uncomfortable even if the puts only represent a very small percentage of assets (as they do here).

Suffice it to say that we are most likely a single number of weeks away from either substantial market losses, or enough stabilization in market action to ease our defensiveness. In any event, we will not maintain our present stance indefinitely.

So far, hopes for massive bailouts and monetary interventions have allowed the market to forestall the more violent follow-through that it experienced in 1973-74, 1987, 2000-2002 and 2007-2009 from similar conditions. Yet the market impact from various monetary actions has become progressively weaker, and the exuberance from various “agreements” out of Europe has become progressively shorter. More importantly, in data spanning more than a century, including Depression, two world wars, rapid inflation, credit crisis, and numerous bubbles and crashes, we’ve seen that relevant global events show up in observable data such as market action, credit spreads, valuations, economic indicators, sentiment, and specific syndromes of conditions. As a result, we don’t need a “Euro breaks up” indicator, or a “Bernanke bubble factor” in our data set, nor do we need a live feed showing constantly refreshed CT-scans of Angela Merkel’s spine.

When the observable data shifts, so will our investment stance. We certainly struggled in 2009 and early 2010 to ensure that our methods were robust to Depression-era data, and the repeated bouts of monetary intervention have narrowed our criteria for establishing staggered-strike hedges, becoming more sensitive to trend-following factors than was necessary prior to 2009. The past few years would have been more comfortable if these adaptations had not been necessary, but they also leave us well-prepared to weather a broad range of potential outcomes, in the expectation of returns that resemble what we’ve achieved in other complete market cycles (e.g. peak-to-peak 2000-2007, trough-to-trough 2002-2009). Both the internet bubble and the housing and credit bubble offered plenty of temptation to believe in a “new era” where historically important market factors were irrelevant. The same temptation exists today despite accelerating global economic challenges. We remain just as unwilling to shift our investment discipline away from testable evidence, or to rely on a blind faith in policymakers to make risk simply go away.

Anatomy of a Bear

Last week, the market re-established the “exhaustion syndrome” that we observed several months ago. The associated rally was uncomfortable, not only because banks and financials advanced (where we hold very little exposure), but also because the advance took our staggered strike put option hedges from in-the-money to out-of-the-money while the CBOE volatility index dropped to just 17. It is easy to forget that we experienced much the same thing near the 2000 and 2007 market peaks. As I noted in the March Who’s Who piece: “A word of caution… When we look at longer-term charts like the one above, it’s easy to see how fleeting the intervening gains turned out to be in hindsight. However, it’s easy to underestimate how utterly excruciating it is to remain hedged during these periods when you actually have to live through day-after-day of advances and small incremental new highs that are repeatedly greeted with enthusiastic headlines and arguments that ‘this time it’s different.’ For us, it’s particularly uncomfortable on days when our stocks don’t perform in line with the overall market, or when the ‘implied volatility’ declines on our option hedges.”

Though our level of defensiveness will remain sensitive to any improvement in our measures of market action, my opinion remains that the global economy is entering a new recession, and that stocks are already in the beginning of a bear market. Because bull and bear markets can only be confirmed in hindsight, we prefer in practice to focus on the broad set of observable evidence at every point in time. Our investment stance is based on that evidence, not my views about recession or bear market status.

As veteran market analyst Richard Russell has noted, investors often equate the concept of a bear market with the expectation that prices will continuously fall. Indeed, if you think back to the 2000-2002 bear, or the 2007-2009 bear, that is probably the memory that those bear markets invoke. In fact, however, those bear markets can be seen on a smaller scale as a constant process of hope and disappointment, with periods of risk-seeking abruptly punished by fresh waves of risk-aversion. This can make it very difficult to live through a bear market day-after-day with a clear sense of the larger picture.

In an attempt to reinforce this picture, the following charts present the initial the 1973-74, 1987, 2000-2002, and 2007-2009 bear markets, respectively. For each period, the initial portion of the bear market is on the left side, while the complete decline is on the right side. Those complete declines represented market losses of about 50% from the highs, except for 1987 which was more abrupt but somewhat less extensive. The final chart shows the S&P 500 from early March through last week. Notably, each of those previous bears started from conditions that match the “Who’s Who” syndrome we observed in March of this year. The feature to notice about these early bear markets is that in each case, despite a hard initial decline, the market recovered within a few percent its bull market high at some point between 2-9 months after the bear market had already started. In effect, investors mounted an “exhaustion rally” despite already deteriorating market internals and rich valuations.

The unusually bad outcomes of similar historical precedents help to convey why we retain such a durable sense of doom, even after last week’s scorching “risk on” advance. Again, a moderate continuation of constructive market action would likely be sufficient to move us to soften our presently hard defense by retreating from a “staggered strike” option hedge. At present, conditions remain aligned with those that have preceded some of the most negative consequences in market history.

On Europe’s Plan to Have a Plan to Have a Memo of Understanding

The following is Friday’s statement from the EU (emphasis added):

“We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.

“We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalisation of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status.

“We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure. These conditions should be reflected in a Memorandum of Understanding. We welcome that the ECB has agreed to serve as an agent to EFSF/ESM in conducting market operations in an effective and efficient manner.

“We task the Eurogroup to implement these decisions by 9 July 2012.”

The upshot here is that Spain’s banks are undercapitalized and insolvent, but rather than take them over and appropriately restructure them in a way that requires bondholders to take losses instead of the public, Spain hopes to tap European bailout funds so that it can provide capital directly to its banks through the European Stability Mechanism (ESM), and put all of Europe’s citizens on the hook for the losses. Spain has been trying to get bailout funds without actually having the government borrow the money, because adding new debt to its books would drive the country further toward sovereign default. Moreover, institutions like the ESM, the ECB, and the IMF generally enjoy senior status on their loans, so that citizens and taxpayers are protected. Spain’s existing bondholders have objected to this, since a bailout for the banks would make their Spanish debt subordinate to the ESM.

As a side note, the statement suggests that Ireland, which already bailed its banks out the old-fashioned way, will demand whatever deal Spain gets.

So the hope is that Europe will agree to establish a single bank supervisor for all of Europe’s banks. After that, the ESM – Europe’s bailout fund – would have the “possibility” to provide capital directly to banks. Of course, since we’re talking about capital – the first buffer against losses – the bailout funds could not simply be lent to the banks, since debt is not capital. Instead, it would have to be provided by directly purchasing stock (though one can imagine the Orwellian possibility of the ESM lending to bank A to buy shares of bank B, and lending to bank B to buy shares of bank A). On the question of whether this is a good idea, as opposed to the alternative of properly restructuring banks, ask Spain how the purchase of Bankia stock has been working out for Spanish citizens (Bankia’s bondholders should at least send a thank-you note). In any event, if this plan for a plan actually goes through, the bailout funds – provided largely by German citizens – would not only lose senior status to Spain’s government debt; the funds would be subordinate even to the unsecured debt held by the bondholders of Spanish banks, since equity is the first thing you wipe out when a bank is insolvent.

It will be interesting to see how long it takes for the German people to figure this out.

Market Climate

It bears repeating that our present defensiveness is not a reflection of European concerns or even our view that the U.S. economy is entering a recession. We try to align our investment position with the prospective return/risk profile that we estimate on the basis of prevailing market conditions, and those conditions are what keep us tightly hedged here. As noted earlier, a moderate further recovery in market internals would move us to reduce the tightness of our hedge, though it’s fair to say that the required improvement is not simply a stone’s throw away and would likely require at least a small number of positive weeks. Here and now, present conditions remain among the most negative in history from a prospective return/risk standpoint. Strategic Growth Fund remains tightly hedged, with a staggered strike position where the additional put option premium at risk represents about 1.8% of total assets. Strategic International also remains fully hedged, and Strategic Dividend has nearly 50% of its stock holdings hedged (its most defensive stance). Strategic Total Return continues to carry a duration of about one year, with about 14% of assets in precious metals shares, and a small percentage of assets in utility shares and foreign currencies.

Copyright © Hussman Funds

Tags: Action Measures, Anatomy, Defensive Position, Defensive Stance, Defensiveness, Exhaustion, Goat, Hedges, Hussman, Hussman Funds, Investment Strategy, John Hussman, Market Losses, Market Outcomes, Market Plunges, Post War, Put Portion, Rodeo, Substantial Market, Syndromes, U S Stock Market
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Panic Is Not a Strategy—Nor Is Greed (Sonders)

Monday, May 14th, 2012

Panic Is Not a Strategy—Nor Is Greed

Updated May 10, 2012
by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• Originally publishing in 2008, it’s time for a refresher about the perils of panic.
• Asset allocation, diversification and rebalancing are as close to a “free lunch” as you can get as an investor.
• In a world where time horizons have shrunk precipitously, think longer-term.

If markets are good at one thing, it’s reminding investors that they don’t go up uninterrupted forever. We witnessed several bruising corrections in 2011 before the market’s strong rally between October 2011 and April 2012. As the chart “Fear Spikes Again” below illustrates, the CBOE Volatility Index® has picked up again, but remains below the unparalleled heights of the 2008 credit crisis and the more-recent elevation in 2011.

Fear Up, But Well Down From Highs

Source: FactSet, as of April 20, 2012. The CBOE Volatility Index (“VIX”) is a registered trademark of the Chicago Board Options Exchange. The VIX Index shows the market’s expectation of 30-day volatility. For more information on the VIX, visit www.cboe.com/micro/vix/

We’re always quick to remind investors that neither panic nor greed is an investment strategy, and that the best foundation to help protect a portfolio against the unpredictable is having—and sticking with—a long-term strategic asset allocation plan.

Mindset matters: strategic trumps tactical

In reality, investors should rarely, if ever, react to a dramatic short-term move in the market. As intriguing as it may seem to try to catch bottoms and get out at tops in order to reap big profits (or so you think), the “tactical” (or shorter-term) approach to investing has its limitations … and its risks.

We believe it’s the “strategic” asset allocation decision—and the ability to stick with it through the discipline of rebalancing—that will ultimately reap the greatest rewards. These decisions are not a function of short-term market gyrations or forecasts (mine, yours or anyone else’s), but are tied to your risk tolerance and long-term goals. Developing and maintaining the right long-term asset mix is by far the most important set of decisions a client will ever make.

Never before has information about the global economy and markets been more readily available and disseminated. As a result, global markets have become very interconnected. In turn, our reaction mechanisms have kicked in, and investor time horizons have shortened dramatically—but not necessarily to our advantage. Yes, the long term is really just a series of short-term events, but it’s how we react to them that decides our ultimate fate as investors.

Asset allocation and diversification: investors’ “free lunch”

One of the most important areas where Schwab offers advice is the development of a long-term strategic asset allocation plan. Many investors assume that their position along the risk spectrum from conservative to aggressive is largely based on their age and time horizon. But a more important factor is their risk tolerance. Also important is judging the difference between an investor’s financial risk tolerance (their ability to financially withstand volatile markets) and their emotional risk tolerance—a spread that’s often quite wide and only acknowledged during tumultuous market environments.

I’ve known plenty of older investors who thrive on the risk associated with an aggressive investment stance. I’ve also known plenty of young investors who can’t stomach any losses. Too often, investors use a rearview mirror to make their investing decisions, by looking at past performance as a guide to future results. A mirror is a valuable tool but only when turned on yourself to judge your own circumstances—tolerance for risk, time horizon, income needs, etc. As I’ve often said, there are very few free lunches in investing. Asset allocation, diversification and periodic rebalancing are as close as you get.

Risk tolerance: Know what you can stomach

In the chart “Schwab’s Strategic Asset Allocation Models” below, you’ll see our long-term recommendations regarding different asset classes for three types of investors: conservative, moderate and aggressive.¹ Note the vast differences in allocations to riskier asset classes, including international equity, as you move up the risk spectrum.

Clearly, over the long term, given the better performance by the riskier asset classes, a more aggressive allocation has historically reaped higher rewards in terms of returns. But there is a dark side to an aggressive posture’s higher returns—the risk taken in getting there.

Tags: Allocation Plan, Cboe Volatility Index, Charles Schwab, Chicago Board Options, Chicago Board Options Exchange, Chief Investment Strategist, Credit Crisis, Diversification, Free Lunch, Greed, Investment Strategy, Liz Ann, Perils, Rewa, Senior Vice President, Strategic Asset Allocation, Term Approach, Time Horizons, Unparalleled Heights, Vix Index, Volatility Index Vix
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Annualized Rebalancing Premium (Nairne)

Tuesday, April 10th, 2012

by Michael Nairne, Tacita Capital

“Buy and hold” is not an effective strategy for risk conscious investors. Any portfolio’s asset mix will drift from its strategic target as asset prices move differentially in response to changing economic and market forces. Over time, the higher return assets will comprise a larger proportion of the portfolio and distort its return and risk dimensions from those originally constructed.

Sound portfolio management is founded on “buy and rebalance”. Rebalancing involves selling the asset classes that have done relatively well to buy those assets that have lagged in order to restore the portfolio’s target mix. Rebalancing is vital in risk management since it ensures that a portfolio’s risk dimensions stay within an investor’s defined tolerance limits. This is illustrated in the following graph which compares the return and risk of a portfolio  comprised of 40% US bonds and 60% US stocks which was rebalanced annually (in red) to those of the same portfolio that was never rebalanced (in orange).

The rebalanced portfolio experienced much lower risk while the never rebalanced portfolio drifted into a much riskier asset weighting dominated by stocks. Its return was lower but that is because it avoided the escalating risk of the never rebalanced portfolio. Critically, the rebalanced portfolio had better risk-adjusted performance .

Rebalancing has a second vital role in a portfolio. Rebalancing is a source of diversification return  that arises from the contrarian act of selling assets that have appreciated on a relative basis and buying the lagging assets in order to restore the weights of the target asset mix of a particular investment strategy.

A return premium is created by the disciplined act of regularly “selling high and buying low” while maintaining the risk profile of the portfolio. It can be calculated by comparing the return of a rebalanced portfolio to the weighted average geometric return of the assets which comprise the portfolio . An example of the rebalancing premium is illustrated in the following table which sets out the returns of the individual assets in the 40% bond/60% stock portfolio, the weighted average return of the two assets, the return of the rebalanced portfolio and the rebalancing premium.

The rebalanced portfolio had an annualized return of 8.60% compared to the weighted average return of 8.06% for the two assets that comprise the portfolio.  Rebalancing resulted in an annualized return premium of 0.54%.

The rebalancing premium can be increased by adding more assets when they exhibit the right blend of volatility and covariance (i.e. tendency to move in tandem) with the overall portfolio – the more volatile the assets added and the lower their covariance, the higher the rebalancing premium. This is illustrated in the following graph which portrays the annualized rebalancing premium for the period January 1972 to January 2012 that resulted from sequentially adding asset classes to a two asset portfolio comprised initially of 40% US bonds and 60% US stocks. The assets added in order are: international stocks, US small value stocks, Canadian stocks, US REITs, and finally gold .

The rebalancing premium more than doubled – from 0.44% to 0.99% – as assets were added. It increased initially as international stocks increased rebalancing opportunities. Then, the addition of volatile small cap value stocks had a large premium as its wide return swings created an even greater rebalancing effect. Adding real estate and commodity-biased Canadian stocks also increased the premium. Finally, adding gold which is very volatile and has a low covariance to other assets had a particularly large premium as there were frequent opportunities for substantive rebalancing.

Earning the rebalancing premium is easier in theory than in practice. Selling winners to buy losers seems to go against human nature. In fact, the vast majority of investors either don’t rebalance or don’t rebalance as frequently as they should .

That’s too bad. Rebalancing earns a return premium while maintaining the risk profile of a portfolio – to paraphrase Scott Willenbrock, rebalancing adds a “free dessert” to the “free lunch” served by diversification.  Serious investors need to stay seated long enough at the investing table to enjoy both.

Footnotes:
1. Bond and stock returns are from Ibbotson’s intermediate-term government bond and large company stock series. Rebalancing is undertaken on an annual basis.
2. Although not shown, the rebalanced portfolio had a higher Sharpe Ratio, Sortino Ratio and M-Squared Ratio.
3. Booth, D.G., Fama, E.F., Diversification Returns and Asset Contributions, Financial Analysts Journal, Vol. 48, No.3, p. 26–32, May/June 1992.  Booth and Fama define the incremental return from a rebalanced portfolio compared to the weighted average asset compound return as the “diversification return”.
4. Willenbrock, Scott, Diversification Return, Portfolio Rebalancing, and the Commodity Return Puzzle, Financial Analysts Journal, Vol. 67, No. 4, pp. 42-49, July/August 2011. Willenbrock states that “the diversification return is the difference between the geometric average returns of both a rebalanced portfolio of volatile assets and a balanced portfolio of hypothetical assets with the same weights and geometric average returns as the true assets but zero volatility.” Practically, the latter term is the weighted average geometric return of the assets comprising the portfolio.
5. All return data is from Morningstar Encorr.  The asset classes are based on the following indices: international stocks – MSCI EAFE; US small value stocks – Fama-French Small Value; Canadian stocks – S&P/TSX Capped Composite in US$;  US REITs – FTSE NAREIT All Equity REIT; and gold – London Fix Gold PM US$. Proportions added vary but are based on practical weighting considerations. Rebalancing is undertaken on an annual basis.
6. AllianceBernstein Investment Research and Management Asset Allocation Research 2005.  Findings of a nationwide telephone survey of 1000 investors.

www.tacitacapital.com

Tacita Capital Inc. (“Tacita”) is a private, independent family office and investment counselling firm that specializes in providing integrated wealth advisory and portfolio management services to families of affluence. We understand the challenges of affluence and apply the leading research and best practices of top financial academics and industry practitioners in assisting our clients reach their goals.

Tacita research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it and is not intended to replace individually tailored investment advice. The asset classes/securities/instruments/strategies discussed may not be suitable for all investors and certain investors may not be eligible to purchase or participate in some or all of them. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Tacita recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor.

Tacita research is prepared for informational purposes. Neither the information nor any opinion expressed constitutes a solicitation by Tacita for the purchase or sale of any securities or financial products. This research is not intended to provide tax, legal, or accounting advice and readers are advised to seek out qualified professionals that provide advice on these issues for their individual circumstances.

Tacita research is based on public information. Tacita makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete.  We have no obligation to inform any parties when opinions, estimates or information in Tacita research changes.

All investments involve risk including loss of principal. The value of and income from investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities transactions.  Past performance is not necessarily a guide to future performance.  Estimates of future performance are based on assumptions that may not be realized. Management fees and expenses are associated with investing.

Tags: Asset Classes, Asset Mix, Asset Prices, Assets, Buy And Hold, Diversification, Graph, Investment Strategy, Portfolio Management, Portfolio Rebalancing, Proportion, Relative Basis, Retu, Risk Management, Risk Profile, Sound Portfolio, Tacita, Target, Tolerance Limits, Weights
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James Grant Says Bond Market Is “Bubble of Modern Banking”

Monday, March 19th, 2012

James Grant, publisher of Grant’s Interest Rate Observer, talks about Federal Reserve monetary policy, the bond market and investment strategy. Grant, speaking with Deirdre Bolton on Bloomberg Television’s “Money Moves,” also discusses the Chinese economy.

Link if video does not play: Bond Market ‘Desert of Value’

Select Interview Quotes

Grant: The Fed seem bent on suppressing this most elegant thing we have called a price mechanism, the movement of price that determines all manner of things in a market economy. Yet the Fed seems bound and determined to superimpose its will in place of the price mechanism. Take the bond market for example, the Fed has hammered down yields directly and indirectly and in response people are throwing money at things like high-yield or junk bonds. These are the prices the Fed wants, but are they the right prices? No not necessarily.

Deirdre Bolton: How is a bond investor to deal with this current environment? You are calling actually for a bear market in bonds, am I correct?.

Grant: I have forever. So I am no help there. But it seems to me a bond investor is almost better off in cash. If you were to go out 10 years in a US treasury security you earn yield of approximate 2%. To remain in cash and be flexible you sacrifice those 2%. The bond market is a desert of value.

Deirdre Bolton: What does this mean for gold?

Grant: The price of gold is the reciprocal of the world’s faith in the deeds and words of the likes of Ben Bernanke. The world over, central banks are printing money as it has never been printed before. The European Central Bank has increased the size of its balance sheet  at the annual rate of 89%. It’s amazing. The Fed is far behind at only 15%. The Bank of England 67% over the past few months. These are rates of increases in the production of paper currencies we have never seen in the modern  age. It takes no effort at all. They simply tap the computer screen.

Time for an “Office of Unintended Consequences?”

Grant proposes the Fed start an “Office of Unintended Consequences” to study all the things that go wrong with Fed policy.

I believe Grant is speaking tongue-in-cheek. We certainly do not need such an office. Instead, we need to abolish the Fed.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Bank Of England, Ben Bernanke, Bloomberg Television, Bond Market, Central Banks, Chinese Economy, Deirdre Bolton, Economy Link, Federal Reserve Monetary Policy, Interest Rate Observer, Investment Strategy, James Grant, Junk Bonds, Market Economy, Paper Currencies, Price Mechanism, Price Of Gold, Printing Money, Treasury Security, Us Treasury
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Jeremy Grantham’s 10 Investment Lessons

Monday, February 27th, 2012

Nice list from Jeremy Grantham, via Marketwatch:

1. Believe in history
“All bubbles break; all investment frenzies pass. The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.”

2. ‘Neither a lender nor a borrower be’
“Leverage reduces the investor’s critical asset: patience. It encourages financial aggressiveness, recklessness and greed.”

3. Don’t put all of your treasure in one boat
“The more investments you have and the more different they are, the more likely you are to survive those critical periods when your big bets move against you.”

4. Be patient and focus on the long term
“Wait for the good cards this will be your margin of safety.”

5. Recognize your advantages over the professionals
“The individual is far better positioned to wait patiently for the right pitch while paying no regard to what others are doing.”

6. Try to contain natural optimism
“Optimism is a lousy investment strategy”

7. On rare occasions, try hard to be brave
“If the numbers tell you it’s a real outlier of a mispriced market, grit your teeth and go for it.”

8. Resist the crowd; cherish numbers only
“Ignore especially the short-term news. The ebb and flow of economic and political news is irrelevant. Do your own simple measurements of value or find a reliable source.”

9. In the end it’s quite simple. really
“[GMO] estimates are not about nuances or Ph.D.s. They are about ignoring the crowd, working out simple ratios and being patient.”

10. ‘This above all: To thine own self be true’
“It is utterly imperative that you know your limitations as well as your strengths and weaknesses. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely must not manage your own money.”

(H/t: Barry Ritholtz, The Big Picture)

Tags: Aggressiveness, Barry Ritholtz, Critical Periods, Ebb And Flow, Grit, Investment Lessons, Investment Strategy, Jeremy Grantham, Lousy Investment, Margin Of Safety, Marketwatch, Nuances, Optimism, Outlier, Political News, Rare Occasions, Recklessness, Strengths And Weaknesses, Term News, Thresholds
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Bruce Berkowitz: “To Survive is to Win, Focus on the Survivors”

Tuesday, February 14th, 2012

After being named Morningstar’s manager of the decade, Bruce Berkowitz had a very rough 2011. His concentrated portfolio, dominated by fallen angels in the financials along with Sears Holdings (SHLD) took a beating.

But as the year turned and investors rotated dramatically into the most beaten down issues of 2011, he has had a bit of a resurgence.

Whatever the case, people don’t get stupid overnight so below are a series of interviews with Bloomberg from Friday.

“Investors are going to do well with all of the survivors,” Berkowitz said in an interview airing today [yesterday] on Bloomberg Television. “If you go back to the late ‘80s, the early ‘90s, the last time we went through this extreme cycle, to survive is to win. And you’re looking at the survivors today.”
 
 
 
 
 
 
 
 

From Bloomberg:

At the end of November, the Fairholme Fund held 81.6 million shares of Bank of America, a stake valued at about $659 million based on last week’s closing price. The fund also held 84.4 million shares in AIG, which would have been valued at $2.25 billion on Feb. 10. Berkowitz also has warrants to buy 21.6 million shares of the insurer at $45 each by January 2021.

Source: Bloomberg

Tags: 6 Million, 80s, Aig, Bank Of America, Bloomberg, Bloomberg Television, Bruce Berkowitz, Decade, Email, Europe, Exiting, Fairholme Fund, Fallen Angels, Financial Crisis, Financial Institutions, Focus, Insurer, Investment Strategy, Investors, Morningstar, Nbsp, Nbsp Nbsp Nbsp Nbsp Nbsp, People, Resurgence, Return On Equity, Sears Holdings, Shld, Survivors, Video 3, Warrants
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Marc Faber: Far Better Off in Precious Metals and Global Stocks Rather Than Bonds

Friday, January 20th, 2012

Jan. 20 (Bloomberg) — Marc Faber, publisher of the Gloom, Boom & Doom report, talks about the outlook for stocks versus bonds and his investment strategy. He speaks with Sara Eisen and Erik Schatzker on Bloomberg Television’s “InsideTrack.” (Source: Bloomberg)

Faber said in the interview, that given the choice between U.S. Treasurys and European bonds, he would choose the U.S. Treasurys; given the choice between equities, real estate, bonds and precious metals, he would choose precious metals and equities.

Eric Schatzker calls Faber out on his bearish 2009 call on U.S. Treasurys, and laughably, Faber admits that David Rosenberg was right, and he owes him a bottle of whiskey.

Length: 5:34 mins

Source: Bloomberg

Tags: Amp, Bloomberg Television, Bonds Investment, Boom, David Rosenberg, Doom, Eisen, Eric, Global Stocks, Gloom, Gloom Boom Doom, Insidetrack, Investment Strategy, Marc Faber, Outlook, precious metals, Publisher, Real Estate, Sara, Stocks Bonds, Treasurys, Whiskey
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