Posts Tagged ‘Merrill Lynch’

David Rosenberg: Where to Go For Positive Returns

Monday, July 23rd, 2012

David Rosenberg discusses how the 3 D’s (Deleveraging, Deflation, and Demographics) are hurting markets, and where investors can go for positive returns, with Wealthtrack’s Consuelo Mack.

Here is the full transcript:

CONSUELO MACK: This week on WealthTrack, the influential economist whose projections have been right on target. Financial Thought Leader David Rosenberg shows how the 3 D’s of deleveraging, deflation and demographics are hurting economies and markets and where investors can go for positive returns, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. This week, we are sitting down for an in-depth interview with one of the handful of prognosticators who has gotten it right going into and through the rolling global financial crisis we are experiencing to this day. He is Financial Thought Leader David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff. Dave returned to his native Canada in 2009 after spending many years as Chief North American Economist at Merrill Lynch, where Institutional Investor magazine placed him on their coveted “All American All Star Team” from 2005-2008.

Rosenberg took on the bullish Wall Street herd as early as 2004, when he started warning about the developing housing and credit bubble which, as he predicted throughout, would wreak havoc on the financial system and many world economies. Well he hit the nail on the head again last year, forecasting the global economy would slow and that treasury bond yields would fall- another homerun. In his influential and widely read daily “Breakfast With Dave” reports, he ranges across the globe covering everything from Europe and how “it is rather incredible that this rolling crisis is now going on 2-1/2 years and policy makers have yet to find a viable solution”; to emerging markets and “why the once mighty BRIC currencies are depreciating of late at their fastest pace since the 1998 Asian crisis”; to the financial markets and “how the “pattern of the past three years is unmistakable as each spring, the equity market corrected as stimulus measures wore off, to only then prompt more incursions by the fall.”

What other patterns are unmistakable to Dave Rosenberg and why did he write in a recent report that “the future is brighter than you think”? I asked him all of the above and more, starting with what he thinks the most important patterns for the economy and markets.

DAVID ROSENBERG: I think the primary trend is still one of deleveraging. It hasn’t really changed much from the last time that the two of us spoke; it’s become much more global in nature. So it started off in the U.S. four or five years ago, in the American mortgage market, the housing market, consumer loans in general, but now we’re seeing how it’s morphed into the survival of the welfare state and all the debt finance to prop up these peripheral countries in Europe, and even now there’s questions about whether China is going to have a hard or soft landing because of a perceived property bubble there.

So we’re still in this deleveraging cycle, still dealing with the impact of too much debt relative to the size of the global economy, and this is what’s creating all this market angst and instability that we’re still living with; notwithstanding the fact that the economy, the U.S. economy is three years in a recovery, we’re still stuck in a very slow growth mode, but recurring financial market instability at the same time.

CONSUELO MACK: So is there any way of knowing whether the second half is going to be worse, better, or the same as the first half? Because, I mean, I’m thinking of my audience out there, and myself included, and saying, “I don’t want to live through another three or four years like this.” So what’s it going to look like, do you think the second half?

DAVID ROSENBERG: Well, I’m going to sound like a classic economist here and say it’s going to be somewhere in between, and this is what I mean. Are we going to get another gut wrenching, you know, 7% decline in GDP, and lose another 8 million jobs? I don’t think we’re going to go through anything close to what we endured in ’08 and ’09.

CONSUELO MACK: And to back-to-back kind of 50% decline in the stock market?

DAVID ROSENBERG: It’s not going to be that bad. But then again, you have to take a look at the contours of the recovery. I actually think the recovery tells you a lot more than the actual gut-wrenching recession did, because normally when you do this with the economy, you do that.

CONSUELO MACK: You get to a V, right?

DAVID ROSENBERG: Well, even in that 1933-’36 period, you got a huge recovery, much bigger than we had this time around, and this time around we had basically a checkmark of left-hand person, that’s what we had. It was not a V-shaped recovery; it was a very meager recovery, especially when you consider everything that the government threw at this thing. Consider the Fed took rates to 0 in December of ’08, they’ve tripled the size of their balance sheet $3 trillion. We’ve had, what, $4 trillion, four years of trillion-dollar deficits, and…

CONSUELO MACK: The fiscal stimulus…

DAVID ROSENBERG: …and more foreclosure moratoria. We’ve tried everything. So we’ve had modest economic growth, but very unacceptable. And now what’s happening is the Fed is left now with all these uncreative tools. Like Ben Bernanke certainly believes that he can do more but, you know, in Economics 101 you learn about the law of diminishing returns, and it’s basically that you end up getting less and less and less incremental impact from the same policies over time. And so that was the same with QE1, QE2, with the LTRO that we had out of Europe. We were getting just a smaller incremental impact on the economy with each individual policy proposal.

CONSUELO MACK: So therefore three years into a quote, unquote “recovery”, so are we on the cusp of another recession?

DAVID ROSENBERG: Cusp or precipice, I don’t know if I’m quite there yet. The economy is extremely fragile. The underlying trend in the economy is barely 2%, it’s barely 2%. So when you have a trade shock that can wipe out 2 percentage points of growth, you’re left with 0. Now, maybe that’s not a recession in the classical sense because we’re not actually going in reverse, but the unemployment rate is going up in a no-growth environment. And then you talk about this so-called fiscal drag, this fiscal cliff that we’re going to see next year- it’s because, you know, we’re probably not in as bad as shape as the Europeans, but here in America, we’ve kicked the can down the road a lot in terms of the Bush tax cuts getting extended, in terms of payroll tax relief, extended unemployment insurance benefits, all these provisions expire December 31st. So just by the government taking back the parking permit from everybody, we have a drag on the economy next year from fiscal restraint, 4 percentage points of GDP, percentage points.

CONSUELO MACK: Which we don’t have. So listening to you, Dave, quite honestly, I do want to kind of bury my head in the sand and I’m thinking to myself, you know, that I want to be in incredibly safe assets, that this is no time to put risk on. And yet, you know, one of the things that you follow, as well, is investor sentiment and the fact that there is a growing despair out there that people are very frightened and worried. And as we know traditionally, that’s in fact, the time when it’s actually best to buy risk.

DAVID ROSENBERG: I mean, there are always opportunities. In a fat-tail world, you’ve got to be very cognizant of the risks. So it’s as much not just focusing on the gross returns, but we have to – and this is what we’re doing every day at my shop at Gluskin Sheff- is we are assessing the risk, identifying it, managing it, and pricing it. And frankly it’s not about, you know, being risk averse. You know, people think that somehow, you know, when you talk about risk all the time you’re risk averse. It’s always important to make sure as an investor that you’re getting paid to take on the risk, that you’re not paying…

CONSUELO MACK: Right, so it’s price is really…

DAVID ROSENBERG: Right. Like, for example, I would say, you know, the high-yield bond market right now is actually, I would argue, priced for a bad economic outcome. You want to buy the assets that you think have already discounted. What’s embedded, what’s the story in this particular asset class, what’s it telling you? So I’m taking a look at the high-yield market right now. I think it’s actually very attractive. We have a core portfolio of high-yield bonds, and the reason I say that is because ultimately when you’re buying corporate bonds, you’re staking a claim in the corporate balance sheet. And the one thing that’s not changed, despite the fact that we’ve got all this angst overseas, the fact that the U.S. economy has hit stall speed, corporate default rates are barely more than 2%, you’ve got corporate balance sheets in great shape whether you look at debt equity ratios, or interest coverage ratios- the fact that treasurers companies both Canada in the U.S. have locked in their maturity schedules, 80% of corporate debt is locked in. In some sense, the corporate sector is in better financial shape than the government sector is. So I like corporate bonds.

CONSUELO MACK: One of the things that you’ve told clients is that reliance and deriving a stable income stream while preserving capital is paramount right now. So in these uncertain times, stability of income stream is one of your major investment focuses.

DAVID ROSENBERG: Right. And it comes down to what my overall theme is called: the macro and market outlook in 3D. So I’m talking about the 3Ds. What are the 3Ds? Well, they’re deflation, there’s demographics, and there is deleveraging and we talked about the deleveraging. There’s also this demographic overlay because the first of the Boomers are 55 going on 56, that’s the median age. The first of the Boomers are in their mid-60s, and so they control the wealth. They’re in a different part of their investment life cycle right now, and so accumulating cash flows as opposed to relying on strictly capital appreciation for the Boomer class, the life cycles as far as investments are concerned, that’s altered. And we’re seeing it in our own business in terms of what our clients are telling us, how they would like their money managed.

So you’ve got the demographics talking about the deleveraging, but the deflation. And so people will say to me, “Well, I thought in a deflation, cash is king in a deflation.” And the answer is well, you know, historically that’s true. That’s the ultimate capital preservation- cash is king in deflationary environment except when interest rates are 0. And so then it’s not cash is king, cash flow is king. So it’s imperative. It’s not just about preservation of capital, which of course in the fat-tail world, which is the deleveraging world, capital preservation is key; but you have to overlay that with preservation of cash flows. That’s why MLPs have been so popular.

CONSUELO MACK: Right, Master Limited Partnerships.

DAVID ROSENBERG: That’s why muni funds. That’s right, and that’s why REITs, and that’s why dividend growth, dividend yield have been so popular now. People come back and say to me, “But these things look so expensive.” Well, they look expensive because that’s what’s in demand, you know? And it doesn’t mean because it’s expensive you don’t want to buy it. You know, the perfume I bought is expensive, yeah, but is it good? Yes. Well, okay, that’s why it’s expensive because it’s a good thing to buy. These are good strategies right now, and that’s why their prices have been up as much as they have.

CONSUELO MACK: So as far as this pattern that we’ve seen for the past three years in the stock market, and where it rallies until the spring and then it basically sells off. That has been very disheartening for investors. Are we locked into that for the foreseeable future?

DAVID ROSENBERG: I think what we have is this battle going on, got this battle. We have the secular forces of deflation coming from all this deleveraging and the deleveraging, of course, takes demand out of the global economy, you’ve got the deflation, and then you’ve got these governments fighting it hard. So the secular forces of deflation in the market place, and then the tug-of-war as governments come in and reflate- whether it’s China, or whether it’s the U.S. government, or whether it’s the ECB. And so what this does is creates tremendous volatility, tremendous volatility.

But once again, the question is for an investor, what do I do with this volatility? How can I sleep at night? And that’s why in conjunction with say income equity over here, and corporate bonds over there, there should be a slice in the portfolio in hedge funds that really hedge long-short strategies that can actually be…

CONSUELO MACK: And they exist? There really are hedge funds that really hedge?

DAVID ROSENBERG: Well, you know, hedge funds have been around for 50 years. They got a bad name in the last cycle because they weren’t hedge funds, they were leverage long-only funds. But there are firms out there that are either hedge funds. You know, Gluskin Sheff is not a hedge fund, but 20% of our business is managing these long-short strategies, and it’s actually a very effective way to be nimble in the market place when you get these dislocations.

It’s really just taking sectors and companies that you think are bad businesses, are going to cut their dividends, and you put a short position on them, and you couple that with long position of the companies that you think are going to grow the dividends over time.

CONSUELO MACK: So let’s talk about earnings, because I know that you’ve said that the E in the price earnings ratio, the earnings, they are problematical. So what is your outlook for corporate earnings? And again, what does that mean for the stock market?

DAVID ROSENBERG: Well, corporate earnings right now have hit an inflection point, and it’s not just that they’re slowing, they’re actually starting to contract. Earnings are actually, after a three-year period of steady increases off those lows in 2009, corporate profits are actually now starting to decline outright.

CONSUELO MACK: And you’re talking about the S&P 500?

DAVID ROSENBERG: S&P 500 and even bigger picture. When we got the GDP numbers a couple of weeks ago- the GDP numbers give you corporate earnings for all of America, not just for the large-cap companies- and corporate earnings are coming down. And my sense is that the earnings estimates by the analysts on Wall Street is still far too high. Earnings estimates are important. I’m noticing that fewer companies are giving guidance. Fewer companies are giving guidance. What’s that telling you? That corporate CEOs, very similarly, they have a very clouded crystal ball right now. Fewer companies are giving guidance, and then the ones that are giving guidance, for every one that’s saying something positive about their business, two to three are saying something negative about what the outlook is. And on top of that, the estimates are starting to come down. I don’t think they’ve come down enough.

What does it mean for the stock market? You know, I think that if we were to go into a recession, normally the market corrects 20%. I’m not going to say that we’re going into a recession, but my sense is that the stock market is going to remain at best in the range that it’s been in for the past several months. We have to respect the range, but we’re going to be still in for a lot of volatility, which is why I was saying before that hedge funds, they really hedged, totally appropriate. On top of that, you have to be nimble and as tactical as you possibly can be, but if you’re going to ask me do I think that there’s more downside pressure given the risks out there, and especially to corporate earnings, the answer is yes. I think at this stage, without getting into, you know, what’s your call on where we can get to, I think the balance of risks is at that the market goes down over the near term and then goes up. And if it does, I think it will be a great buying opportunity down the road.

CONSUELO MACK: Let me ask you just about another macro issue, which is what about Europe? And you’ve said, you wrote recently that, you know, you’re two and a half years in, you know, these rolling problems keep coming up in Europe, and there are no viable solutions.

DAVID ROSENBERG: Well, I mean, there are solutions. I don’t know how viable they are. I think it’s a matter of just looking at it realistically. The European Union was working just fine. You know, the whole notion that we were going to try and avoid another World War, another European war at all costs. I don’t think that we needed to have a currency union to achieve that. You can’t have a monetary union and not have the fiscal union, and an integrated banking union. You can’t have it.

CONSUELO MACK: So realistically, I mean, are the 17 countries going to sacrifice their sovereignty?

DAVID ROSENBERG: Hardly likely. I had breakfast recently with a CEO of a major Canadian bank, and he told me that they have a Eurozone breakup committee. And he said this is happening around the world. Any major multinational corporation, any business that is doing business in Europe has one of these Eurozone breakup committees, not unlike the pre-Y2K committees that you had in the late 1990s. So you can bet your bottom Euro that if that’s what they’re doing, the Eurocrats in Brussels are trying to come up with some sort of… you talk about viable, what’s a viable exit strategy? Unless the ECB steps up en masse and rapidly expands its balance sheet, and starts buying the bonds of Italy and Spain en masse at auction, you know, that’s pretty radical. I don’t know what the quick fix is. So I think that the end game will ultimately be that the Eurozone breaks up.

CONSUELO MACK: One of your investment themes that we’ve talked about basically has been capital preservation and income orientation, as well, and one of the themes that you and I have talked about in the past is what you call “SIRP”, which is Safety and Income at a Reasonable Price. Are you looking for SIRP investments? Is that still a major strategy theme?

DAVID ROSENBERG: I would say that SIRP has its thumbprints across all the portfolios we’re running at Gluskin Sheff. In fact, what’s interesting is that we, for years, since 2001 we’re running this one particular strategy that’s called “premium income”, which it’s a hybrid, it’s got dividends, and it could have REITs, it could have preferred, convertible bonds; it’s really a portfolio aimed at distribution, a portfolio aimed at generating monthly cash flows for our clients.

CONSUELO MACK: And that’s Safety and Income at a Reasonable Price.

DAVID ROSENBERG: Right. Well, when we say… for example, when I talked about corporate bonds, and we’re talking about “safety” in quotes; I mean, safety, it’s relative. When talking about corporate bonds, it’s because of the quality of the balance sheets are very strong. Because that’s inherently when you’re buying corporate bonds, it’s mostly about default risk. You want to minimize that strong balance sheets. When I talk about on the equity side, we’re talking about running portfolios that have a low beta, which means low correlations with the overall market direction.

CONSUELO MACK: Right. The overall stock market direction.

DAVID ROSENBERG: The overall stock market direction, so we’re talking about, so it’s not just about, you know, does this company have a consistent history of paying off dividends, and we like the business. It’s also how does it move relative to the overall market? So in a period like this where it’s very tumultuous, and where the market is more prone to go down than up, you want to run your portfolios with very low betas. And so that’s the safety part, that’s the “S” part of the SIRP.

CONSUELO MACK: And the low correlations of the markets, in a highly correlated market, which is what we’ve been in for the last several years, so what are the areas that aren’t correlated that have low betas?

DAVID ROSENBERG: Well, for example, one of the themes that we liked has been the consumer frugality theme. So it means consignment stores, it means private label, it means do-it-yourselfers. I mean, for example, you could actually say, wow, because a Home Depot, does it fall under that category as an example. I’m not going to go sell my home, I’m not going to move, I’m underwater in my mortgage, but you know what? I still want to have a fun life, so instead of buying a new home, I’ll spruce up my existing home. And so home repair, a do-it-yourselfer, and so you can find…

CONSUELO MACK: So can you match a name or two to, you know, the frugality theme? So, for instance, frugality, what’s a–

DAVID ROSENBERG: Well, I’ll tell you one area where we have been long, and it’s worked out well has been the dollar stores. And they’ve been phenomenal investments, and by the way, it’s not just because low income households shop there, you’d find… and what the studies are showing is that a greater share of middle income households are actually going to dollar stores. And that’s an area where we have focused on in terms of our consumer exposure.

CONSUELO MACK: Let me run down a couple of the other investment themes, noncyclical. So give me, you know, what’s the theory behind the noncyclical emphasis? And give me an idea.

DAVID ROSENBERG: Well, it’s all about generating stable cash flows. In an uncertain environment, what do you want in an uncertain environment? You want stability. What about utilities, regulated utilities? Regulated utilities. They have regulated pricing power. What about telecom? And it might not just be the stock, you might want to buy the bonds of these companies. Once again, if you have a single A telecom company that’s giving you a triple B yield, you know, I will be happy to take that all day long in terms of looking at the risk and reward. So telecom, utilities, consumer staples, these are the areas that will tend to outperform in the environment that I’m describing right now.

CONSUELO MACK: And one other category that you had was hard assets. So what are we talking about when you’re emphasizing hard assets?

DAVID ROSENBERG: Resources are not a bad place to be. They’re already corrected quite a bit, so resources, whether it’s raw food, or whether it’s, I would say energy, which is corrected quite a bit. ]If you’re a long-term investor, these are complements. They’re not going to generate a yield for you, but they are what you want to own, things you can see, touch and feel in a very uncertain world, and these things have cheapened up quite a bit, as a hedge against the income part of the portfolio.

CONSUELO MACK: So one question is One Investment for long-term to diversify portfolio, what is it that you would recommend that we all own some of?

DAVID ROSENBERG: Well, I’m still a big advocate of corporate bonds. As I said, I think balance sheets are in great shape, default rates are low, there is too much default risk priced in, and so I would say I would focus on, let’s try and generate equity-like returns without taking on the equity risk. And there is a part of the capital structure that can accomplish that, and it’s called “corporate credit”. That is still to me a happy medium between 0 percent treasury bills and going out in the riskiest part of the equity structure. So corporate bonds to me are a solid investment.

CONSUELO MACK: And Dave Rosenberg, you know, you have a reputation of being a permabear, which is not fair, because you were also known as a permabull in the ‘80s and the ‘90s, and in a recent report you said” the future is brighter than you think.” Why when others are despairing are you getting enthusiastic about the future?

DAVID ROSENBERG: Well, I’m not going to say I’m getting enthusiastic about the future. What I am willing to do is put out some checkmarks as to what can cause me to turn more optimistic. And so I see a flicker of light, and it’s realization that politics will lead the financial markets, which will lead the economy, and what leads the politics is the grassroots level, and so what happened last month, for example, I think in Wisconsin with the recall in San Jose, San Diego, and there seems to be this growing realization at the grassroots level that we have to get our public sector balance sheets in better shape; that these underfunded liabilities have to come under control. So we’re starting to see more of a groundswell of support.

What I’m thinking about is how things will change politically on November the 6th, understanding, coming from Canada; Canada went through what Europe is going through right now. Canada is going through what the U.S. was going through back in the early 1990s. You could never have predicted that Canada ten years later would be the poster child for fiscal integrity globally. But it took tremendous political courage.

CONSUELO MACK: We’ll see what happens, and that’s what you’re going to be watching, Dave Rosenberg.

DAVID ROSENBERG: I’m more than willing to reclaim my status of a permabull that I had in the ‘80s and ‘90s if I see those clouds part come November.

CONSUELO MACK: All right, Dave Rosenberg, so great to have you here from Canada, Gluskin Sheff. It always a pleasure to have you on WealthTrack.

DAVID ROSENBERG: Thank you.

CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s reiterates one we just talked about- Dave Rosenberg’s long-time income generating strategies which is S.I.R.P.: safety and income at a reasonable price. So this week’s Action Point is: seek safety and income at a reasonable price, or S.I.R.P.!

Everything we know about the financial markets right now points to ongoing volatility and headwinds for stock price appreciation. Among the areas Rosenberg recommends where you can find reliable dividend growth and dividend yields are: Canadian and U.S. preferred stock shares, which are senior to common stocks; energy infrastructure investments, such as natural gas pipelines; and utilities. All S.I.R.P. vehicles.

And that concludes this edition of WealthTrack. I hope you can join us next week. We are going to sit down with an investment professional who combines two disciplines: overall investment strategy and actual fund management. BlackRock consultant Bob Doll will join us to discuss macro trends and micro strategies. Until then, to see this program again, or others and read my Action Points and our guests’ One Investment recommendations, please visit our website, wealthtrack.com Have a great weekend and make the week ahead a productive one.

Tags: American Economist, Chief Economist, Consuelo Mack, Credit Bubble, David Rosenberg, Deflation, Demographics, Depth Interview, Global Economy, Global Financial Crisis, Institutional Investor Magazine, Investors, Merrill Lynch, Native Canada, Prognosticators, Sheff, Target, Treasury Bond Yields, Viable Solution, Wealth Management Firm, Wealthtrack, World Economies
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Sell Side Analysts at Most Bearish in 15 Years – Good Contrarian Signal?

Wednesday, July 4th, 2012

If there is one group that is almost never bearish it is sell side analysts – you know the ones, those who almost never issue a sell recommendation. [Dec 5, 2007: The Games Analysts Play - Why Almost No One Says Sell] After all Wall Street sell side analysis is all about ~~making sure you never upset the company because you might lose business with them in the future~~ advising clients on company prospects in an accurate way.

According to BofA Merrill Lynch, the sell side appears to be the most bearish it has been in 15 years. For the contrarians out there, that might be another near term positive.

The Sell Side Indicator is based on the average recommended equity allocation of Wall Street strategists as of the last business day of each month. We have found that Wall Street’s consensus equity allocation has historically been a reliable contrary indicator. In other words, it has historically been a bullish signal when Wall Street was extremely bearish, and vice versa. See our November report for more details on the Sell Side Indicator.

Tags: Bofa, Bullish Signal, Business Day, Consensus, Contrarians, Equity Allocation, Games Play, Last Business, Merrill Lynch, Prospects, Strategists, Vice Versa, Wall Street
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David Rosenberg (Strategic Investment Conference)

Monday, May 7th, 2012

Submitted by Lance Roberts of Streettalk Advisors

Guest Post: Strategic Investment Conference: David Rosenberg

STRATEGIC INVESTMENT CONFERENCE – DAY 1

If you haven’t read the notes from the first two speakers, Niall Ferguson and Dr. Woody Brock, I encourage you to do so. The next speaker at the conference is a friend of mine and one of the most widely regarded economists today. David Rosenberg was previously the Chief Economist at Merrill Lynch and is now the Chief Economist and Investment Strategist at Gluskin-Sheff. Here are his thoughts.

The 3-D’s Deflation, Deleveraging and Demographics

“People continually label me a “perma-bear” which is very inaccurate. I have been a perma-bull on fixed income for a very long time. The reason that Gluskin-Sheff hired me is that my job is to take the economic data points and put them together in a structure from which investments can be made.”

“A Forecast is nothing more than the midpoint of a distribution curve.”

When you talk about risk often enough you get classified as a “perma-bear”. The corner stone of asset management is not capital “appreciation” but capital “preservation”.

In the second year of this economic recovery (2011) the economy was growing at 1.6%. This is important to understand because in a “normal” recovery the economy should be growing at 5-6% at this same point.

Bob Farrell’s 10 Market Rules: The 10 Commandments To Remember

1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
9. When all the experts and forecasts agree — something else is going to happen
10. Bull markets are more fun than bear markets.

These are the ten commandments of investing. Not understanding this is what leads to individuals losing large amounts of money over time.

Rules #1 and #9 are the most important to conversation today.

The markets tend to return to the mean over time. Understand this. Just this year there have been two very important covers from Barron’s.

February 2012 – Barron’s Dow 15000
April 2012 – Barron’s – Outlook Mostly Sunny.

Barron’s has an absolutely horrible track record of putting on their covers bullish sentiment at just about the peak of the market. (He showed many examples of Barron’s covers going back over the past decade.)

At the point of peak bullishness by investors and money managers is when the “reversion” effect will occur. In other words, whatever Barron’s puts on their cover you are wise to do the opposite.

The “Fiscal Cliff”

Under status quo at the end of 2012 roughly 42 tax benefits will expire at the end of 2012. At that point there will be record drag (roughly 4%) on GDP from reduction of those tax benefits to spending. Since the economy is currently barely growing at 2% do the math – a negative 2% economic growth rate is a very large recession.

Ben Bernanke – the Fed has NO ability to offset the impact of the “fiscal cliff.” By the way – recessions tend to happen in the first year of the Presidential cycle.

The last two times, 1960 and 1969, that there was a fiscal retrenchment of the same magnitude both ended in recessions. If there is any one thing to worry about it will be this particular event more than just about anything else.

What about government spending? US government spending runs at approximately $1.50 for every $1.00 brought in. This level of spending is unheard of outside of WWII and is very unsustainable. Furthermore, the longer that this excessive level of debt based spending occurs the more that it becomes a structural problem. Interest payments are at a record share of total revenue as well as the debt as a share of GDP. The high level of debt to GDP, and the subsequent servicing of that debt via interest payments, reduces economic growth. This leads to the real problem facing the U.S. today…Deflation.

Outside of commodity based inflation there is deflation running in everything else from incomes to real estate. This deflation impacts the base of the consumer and the economy. Take a look at the current output gap which is still at some of the largest levels on record. The current economic growth rate is too weak to offset the current slack in the economy.

This is why QE3 is coming and is just a matter of timing.

The deflation in housing is going to continue. Housing is only about 40% through its reversion process. In fact, along with housing, the entire household debt deleveraging process is still in progress and still has a tremendous way to go. This deleveraging cycle will remain a dead-weight drag on the economy for quite a long time.

It is important to understand that the debt bubble didn’t happen in 3 years and it won’t be cured in three years either.

According to the recent McKinsey study the debt deleveraging cycles, in normal historical recessionary cycles, lasted on average six to seven years, with total debt as a percentage of GDP declining by roughly 25 percent. More importantly, while GDP contracted in the initial years of the deleveraging cycle it rebounded in the later years.

A further pressure on the economy remains excess unemployment. There are roughly 20 million still unemployed versus the long term average of about 13 million. The excess capacity of labor suppresses wages and economic growth. In other words, excess employment leads to deflationary economic pressures.

In regards to employment the only real report to watch is the U-6 report, versus U-3, because it is the most inclusive measure of unemployment. If two full time employees are converted to part time they are not included in the U-3 report but will show up in the U-6 report. The U-6 level of unemployment is still at a higher level than at any other recessionary period.

As I stated, high levels of unemployment, or excess slack in the labor market, leads to deflation in wages. Deflation is wages is very problematic and has a lot do with deflationary prices in the economy.

So, deflationary pressures are why I am still bullish on bonds versus stocks.

Here is an interesting side note. What correlates with bond yields?

88% Fed Policy
75% Core CPI
64% CPI inflation

With the Fed keeping yields at zero through 2014 there is NO rate risk in owning bonds. When bond yields jump up for any reason it is a buying opportunity UNTIL the Fed starts taking the punch bowl away.

Historically, the average yield curve spread between the short and long dated maturities is about 160 basis points. Currently, that spread is about 330 basis points. That spread will revert to the average over time which means that the long bond yield is going to 2%. Buy Bonds and you will get a better return than owning stocks with dramatically less risk.

What type of bonds? I like corporate bonds. Corporate balance sheets are great and have been cleaned up tremendously since the recession. The current corporate default rate is 2% and companies that are BB or BBB rated that have an A rated balance sheet make a lot of sense. There is no debate between stocks and bonds. Bonds are a contractual agreement to pay interest and repay principal over a specified period of time.

Stocks are currently priced for a 10% growth rate which makes bonds a safer investment in the current environment which cannot deliver 10% rates of returns. We are no longer in the era of capital appreciation and growth. The “baby boomers” are driving the demand for income which will keep pressure on finding yield which in turn reduces buying pressure on stocks. This is why even with the current stock market rally since the 2009 lows – equity funds have seen continual outflows. The “Capital Preservation” crowd will continue to grow relative to the “Capital Appreciation” crowd.

Investment Stategy – Safety and Income at a Reasonable Price

1. Focus on Safe Yield – Corporate bonds
2. Equities – Dividend growth and yield, preferred shares
3. Focus on companies with low debt/equity ratios and high liquid asset ratios. The balance sheet is more important than usual.
4. Hard assets that provide an income stream – oil and gas royalties, REITS.
5. Focus on sectors or companies with low fixed costs, high variable cost, high barriers to entry, high level of demand inelasticity.
6. Alternative assets – that are not reliant on rising equity markets and where volatility can be used to advantage.
7. Precious Metals – hedge against reflationary policies aimed at defusing deflationary risks.

Tags: Bob Farrell, Capital Appreciation, Capital Preservation, Chief Economist, Chip Names, David Rosenberg, Deflation, Distribution Curve, Economic Data, Economic Recovery, Eras, Excesses, Fixed Income, Gluskin Sheff, Investment Conference, Investment Strategist, Lance Roberts, Merrill Lynch, Midpoint, Point Bob, Streettalk
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Bob Farrell’s 10 Rules for Investing

Friday, May 4th, 2012

Wall Street “gurus” come and go, but in the case of Bob Farrell legend status was achieved. He spent several decades as chief stock market analyst at Merrill Lynch & Co. and had a front-row seat at the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987 crash.

Farrell retired in 1992, but his famous “10 Market Rules to Remember” have lived on and are summarized below, courtesy of The Big Picture and MarketWatch (June 2008). The words of wisdom are timeless and are especially appropriate at the start of a new year as investors grapple with the difficult juncture at which stock markets find themselves at this stage.

1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.

2. Excesses in one direction will lead to an excess in the opposite direction
Think of the market baseline as attached to a rubber string. Any action too far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.

3. There are no new eras – excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots.

As the fever builds, a chorus of “this time it’s different” will be heard, even if those exact words are never used. And of course, it – human nature – is never different.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don’t expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction eventually.

5. The public buys the most at the top and the least at the bottom
That’s why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing. Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors Survey.

6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains “make us exuberant; they enhance well-being and promote optimism”, says Santa Clara University finance professor Meir Statman. His studies of investor behavior show that “losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks.”

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
This is why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks.

8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend

9. When all the experts and forecasts agree – something else is going to happen
As Sam Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

10. Bull markets are more fun than bear markets
Especially if you are long only or mandated to be fully invested. Those with more flexible charters might squeak out a smile or two here and there.

Sources: The Big Picture, 17 August, 2008 and MarketWatch, June 11, 2008.

Tags: Bear Market, Bob Farrell, Eras, Euphoria, Exact Words, Excesses, Heat Of The Moment, Juncture, Legend Status, Merrill Lynch, Mid 1980s, Minded Investors, Overshoot, Pessimism, Row Seat, Rubber String, Stock Market Analyst, Stock Markets, Wall Street Gurus, Words Of Wisdom
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Investors Losing Faith in Hedge Funds?

Friday, March 9th, 2012

Nathan Vardi of Forbes reports, Investors Are Starting To Lose Faith In Hedge Funds:

For a long time, it seemed like nothing could diminish investor appetite for hedge funds. Even after the financial crisis embarrassed some of the industry’s most high-profile investors and caused the industry’s assets to tumble as hundreds of hedge fund closed in 2008, the hedge fund business quickly recovered. Last year the industry’s assets reached an all-time high of $2 trillion.

But 2011 turned out to be one of the hedge fund industry’s worst years ever. The average hedge fund fell by 5%. The average hedge fund specializing in equities fell by 8%. Hedge fund titans like billionaire John Paulson had a terrible year and lost massive amounts of money. At the same time, the S&P 500 returned a positive 2%. Evidence has started to emerge that some investors may have had enough.

According to research firms Barclays Hedge and TrimTabs, investors redeemed $15.2 billion from hedge funds in January, the highest outflow since the height of the credit crisis in January 2009.

This could only be the start of a river of outflows if hedge fund performance doesn’t improve soon. In January, hedge funds again trailed the U.S. stock market. The average hedge fund posted a positive return of 3.1%, underperforming the S&P 500, which returned 4.2% in January. Bank of America Merrill Lynch says that its investable hedge fund composite index was up 1.19% in February, yet still underperformed the S&P 500 by 2.87%.

“If hedge funds don’t deliver in aggregate this year, it is going to be a very real problem for the industry,” says Brad Balter, a Boston-based investment advisor who oversees just under $1 billion and farms out money to hedge funds. “2011 had a very volatile 3^rd quarter which hurt everyone, but if we go through another period of underperformance investors will question using them.”

FINalternatives also reports, Hedge fund redemptions , assets up in February:

Investors pulled $15.2 billion from hedge funds in January 2012, as overall industry assets climbed to $1.70 trillion from $1.68 trillion at end-2011.

According to BarclayHedge and TrimTabs Investment Research, hedge funds underperformed the S&P 500 by 110 basis points for the month.

“Hedge funds managed a 3.1% return in January after posting losses in seven out of the last eight months of 2011,” said Sol Waksman, founder and president of BarclayHedge. The benchmark S&P 500 Index returned 4.2% in January after outperforming the hedge fund industry for all of 2011.

“January marked the biggest monthly outflow since July 2009, when hedge funds redeemed $17.7 billion,” said Leon Mirochnik, an analyst at TrimTabs. “The hedge fund industry has experienced net outflows in four out of the last five months.”

Fixed income, multi-strategy, and merger arbitrage hedge funds are the only strategies to have seen net inflows since September 2011. Multi-strategy funds led, pulling in $2.6 billion in January. Mirochnik says investors seem to be “piling into strategies that can benefit from geopolitical uncertainty around the world.”

Funds of hedge funds underperformed their hedge fund counterparts by 140 bps, returning 1.7% in January and Mirochnik thinks FoF managers might have difficulty explaining “their layers of fees” to clients given that funds of funds have underperformed hedge funds by 200 bps over the past year.

In related news, hedge fund managers polled by TrimTabs/BarclayHedge remain bullish on U.S. securities, although the sentiment was less marked in February 2012 than in the previous month. Of the 105 hedge fund managers surveyed in the third week of February 2012, 40% were bullish on the S&P 500, compared to 45.4% in January. Bearish sentiment rose to 30.5% in February from 25.0% in January.

Nearly 30.0% of managers believe that U.S. equities will be the top-performing investment over the next three months. Gold came in second at nearly 23.0% followed by oil with 20.0%.

So what is going on? Are investors “losing faith” in hedge funds? Not exactly. They are simply becoming more aware that most hedge funds are full of it, charging 2% management fee and 20% performance fee for beta. And as we saw in 2011, most hedge funds had a a hard time even delivering beta, underperforming the market.

All this prompted Mindful Money to ask, Is this the end of the hedge fund manager?:

The headline that hedge fund bosses seem to have made a bit of cash in 2011 will hardly surprise many of the cynics who see them as more bogeymen of the financial services industry, alongside bankers. But these inflated pay-packets certainly seem counterintuitive at a time when many are predicting the end of the hedge fund manager altogether.

This Reuters piece, based on a Forbes survey showed that: “The top 40 highest-earning hedge fund managers took home a combined $13.2 billion… The top 10 hedge fund managers made more than $200 million each, while the lowest earning managers made $40 million each.”

But the report coincides with a Times article (paywall) predicting the end of an era for hedge fund managers: “Last year was a disaster for the $2 trillion hedge-fund industry. Desperately hoping for a recovery from the 2008 financial crisis, hedge funds actually lost investors 5 per cent in 2011, with some slipping as much as 50 per cent. Investors pulled millions of pounds out and hundreds of smaller hedge funds have closed.”

One analyst, who recently left a hedge fund, is quoted as saying: “The industry’s gone through cataclysmic change. There’s much more scrutiny. People are asked to work harder, in a more regulated environment, for less money. Everything’s more serious – you can’t send rude e-mails any more – it’s death by a thousand cuts.”

So how to explain these giant pay-packers? The Reuters article points to the fact that the more successful hedge funds are mopping up disillusioned investment bankers ahead of the imposition of the Volker rule, which seems to have benefited groups such as Europe’s Brevin Howard.

There certainly is more interest in alternatives. The most recent Morningstar fund flows survey showed that as risk appetite has increased, so has interest in alternatives: “Other broad asset classes also reversed the negative momentum of 2011′s second half. Funds in the allocation, alternatives, and commodities groups all enjoyed modest inflows in January.”

But this is benefiting some groups more than others. Man Group, the largest listed hedge fund managers has reversed a run of difficult performance: “Man said assets under management had risen to $59.5bn from $58.4bn at the end of December. Chief executive Peter Clarke told Reuters: If sentiment is maintained and performance continues, we’d expect it to translate into rising sales and net inflows. Man also held its dividend payment, which some analysts had suggested might be cut.”

The big money has tended to be made in the larger macro hedge funds, which have been able to use the market volatility to their advantage. The trouble is that the environment has exposed those hedge funds that are not doing anything very different to long-only managers and charging a lot more for it.

This Zerohedge article goes some way to exposing the lack of imagination in some hedge funds. It points to Goldman research into hedge funds, which demonstrates, among other points, that; “hedge fund returns are highly dependent on the performance of a few key stocks. The typical hedge fund has an average of 64% of its long equity assets invested in its 10 largest positions compared with 34% for the typical large-cap mutual fund, 18% for a small-cap mutual fund, 20% for the S&P 500 and just 2% for the Russell 2000 index.” Secondly, the Goldman research found: “Apple (AAPL) matters. One out of five long/short hedge funds has AAPL among its ten largest long positions and approximately 30% of hedge funds own at least one share of AAPL. When it ranks among the top ten holdings, AAPL represents an average of 8% of single-stock long equity exposure. In aggregate, hedge funds own only 4% of AAPL equity cap. The average hedge fund AAPL position equals 1.6%, given 70% of funds own no AAPL.”

As the Times piece points out, both markets and investors are getting smarter. The credit crisis exposed the limitations of the hedge fund industry and created a new scepticism about financial services generally: “In his book The Hedge Fund Mirage, industry insider Simon Lack calculated that between 1998 and 2010 hedge-fund managers earned an estimated $379 billion in fees, out of total investment gains of $449 billion. In other words, they took 84 per cent of the investment profits, leaving just 15 per cent for investors.” This may work in bullish times, but not when investors are short of cash and have Madoff in the back of their minds.

Weakening returns have also exposed the high fixed costs of some hedge funds: “While some larger hedge funds are still profitable, many smaller ones cannot afford the high Mayfair rents they took for granted until recently” says the article.

In other words, the hedge fund industry is the same as any other, the strong are getting stronger and the weak are falling away. The credit crunch has ensured that the hedge fund industry is becoming as Darwinist as any other.

The strong are getting stronger, able to attract talent because they have the big bucks to pay top managers, but it goes far beyond this.

According to the fifth annual global study released by SEI in collaboration with Greenwich Associates, with significant dollars poised to flow into hedge funds in 2012, managers must address investor transparency and liquidity concerns to take advantage of new funding opportunities:

The second report in the two-part series, entitled “The New Dynamics of Hedge Fund Competitiveness,” indicates a need for hedge fund managers to move beyond portfolio transparency to provide investors with consistent and insightful communications along with direct access to investment teams. Liquidity and the inability to control exit strategies have also emerged as key concerns for hedge fund investors.

“Transparency has been the focus for managers in recent years, but we’re seeing clients look for increased personal interaction and dialogue. This Era of the Investor™ is pushing managers to look beyond standard expectations,” said Philip Masterson, Senior Vice President and Head of Business Development, Europe, for SEI’s Investment Manager Services division. “The environment is shifting and while managers are showing improvements in reporting, the study shows that portfolio transparency is simply not enough to satisfy investors anymore.”

Beyond communication, the survey shows that investors want greater detail in terms of security-level disclosure, including leverage detail, valuation methodology, and risk analytics. The study also showed that liquidity has emerged as a key area of concern among investors. Nearly a third of respondents (31 percent) cited ongoing liquidity risk among their biggest hedge fund investing worries, while “an inability to control exit strategy” was named by 46 percent of respondents.

“Evaluating and selecting fund managers has always been a top-of-mind concern for investors,” said Rodger Smith, Managing Director of Greenwich Associates. “What this study brought to light is that, as long as they can articulate their value proposition and differentiate themselves from their peers, there is a place for smaller and newer funds in institutional portfolios. In fact, one in five investors polled said they have no asset minimum requirements in order to invest, and while a majority of those surveyed said they seek hedge funds with a history of at least three years, roughly a quarter would consider less, and 14 percent would not eliminate a fund without a track record at all.”

Highlighting the increasing inability of investors to distinguish among strategies, 17 percent of respondents said manager selection is the single most important challenge facing hedge fund investors today. While 95 percent of respondents said clarity of investment philosophy is important or very important in the selection process, more than half of respondents (61 percent) said there are too many look-alike strategies in the hedge fund industry.

Given that challenge, more than half of respondents (51 percent) said hedge funds are too complex to evaluate without a consultant’s help. Respondents were decidedly mixed on the importance of brand in the selection process, while operations are clearly a critical aspect in selecting managers, with 80 percent of those polled agreeing that operational strength is a hallmark of an institutional-quality fund.

The white paper is published by the SEI Knowledge Partnership, which provides ongoing business intelligence and guidance to SEI’s investment manager clients. To request the full paper, visit http://www.seic.com/HedgeResearch2012.

Some consultants are working to address investors’ concerns over liquidity and transparency. Roger Kenyon, Senior VP at FIS Group, told me they have found a way to address the liquidity, transparency and investment concerns of investors looking to allocate to emerging hedge fund managers. Roger sent me these comments:

Investors have always been interested in investing in emerging hedge fund managers. No doubt this has been a natural inquisitiveness about anything new; the hope of discovering a spectacular talent; and also a possible morbid belief in discovering a future blow up. Research shows that new managers with limited assets to manage outperform more established managers.

Yet this has not prevented investors from introducing all sorts of preconditions that the manager must satisfy before investors will act. Even the definition of what constitutes an emerging manager seems to be unsettled. In the long-only area some investors define the category to be managers with assets below $2 Billion. Among hedge fund investors the cutoff seems to be $200 MM.

The difficulty in getting access to funding by emerging managers is primarily due to the fact that they do not share the same characteristics of established managers. This does not refer to their potential to produce skill based returns, but primarily to the absence of the support infrastructure of larger funds.

These structures usually provide investors with a sense of confidence that management is governed with features such as oversight, liquidity and transparency. Emerging managers would not be so classified if they were required to build up these capabilities before starting a business as the time and costs would be severe impediments.

Luckily, the market has responded to this gap and has addressed these infrastructure problems in a comprehensive manner. Emerging managers can now access all the institutional level back up required to produce accurate and timely valuations, counterparty controls, risk controls and limit monitoring. In this way the manager has the freedom to leverage his investment skills; and the investor can be confident in the investment decision because of the high level transparency.

The characteristics of these processes cannot be undervalued. They allow a smooth flow of information in periods agreed upon by both manager and investor. These periods can be daily or wider spaced. Each partner can communicate with each other as needed. Investors can view the information from a viewpoint chosen by the investor. No longer will the investor wait for the manager to an interpret performance. He will have seen the results and he will have been able to see whether they were within his investment framework.

Needless to say, both manager and investor can set benchmarks, allowable securities, risk controls, and general operating features that both feel comfortable with. With this capability in place, concerns about performance, strategy, strategy drift, use of cash, leverage, and tracking error and returns attribution can be analyzed rather than be an issue of uncertainty .

These types of facilities should provide investors to be more aggressive in sourcing, investing and having a positive returns experience with emerging managers. Investors will be able to continually tailor their allocations as required because they can be assured of being able to call on the liquidity conditions which were agreed.

Roger and I discussed how useless monthly “risk transparency” reports are and how investors who are looking to allocate to emerging managers are adopting this new approach to manage risk properly.

I cannot stress how important it is to look at emerging alpha talent, especially in this environment where there is a placebo effect of investing in large hedge funds. There is talent out there worth seeding but investors have to approach the seeding game a lot more intelligently.

Reuters reports that HSBC’s alternative asset management arm is scouring the market for promising new hedge fund managers, whose ranks are swelling ahead of the imposition of the Volcker rule, which cracks down on banks trading with their own money:

The rule could prove a boon for HSBC’s recently launched emerging manager programme as it is providing hedge fund managers across strategies such as long-short equity, distressed debt and trading funds.

“Several opportunities are arising from the Volcker rule. People are leaving the banks and launching their own funds,” Peter Rigg, head of HSBC’s alternative investment group told Reuters at a presentation in Zurich.

The Volcker rule, named after former Federal Reserve Chairman Paul Volcker, prohibits banks from trading with their own funds for profit, encouraging so-called proprietary traders to set up shop on their own.

U.S. regulators said on Wednesday they are unlikely to have the rule finalised by a July deadline, but many managers are still exiting banks ahead of when the ban is due to come into force.

Ex-Goldman Sachs stars like Pierre-Henri Flamand and Morgan Sze are among those to have already made the move.

Rigg said many managers perform best in the early years, when their funds are still small and they rely on strong returns to earn performance fees and draw in clients, rather than living off management fees levied on large asset bases.

He said HSBC’s $38 billion (23.8 billion pound) alternatives investment business can negotiate good fee discounts with these managers which it then passes on to its clients.

Rigg said HSBC’s funds of hedge funds were currently in “risk off” mode, meaning they are underweight strategies like long-short equities which rely more on market fundamentals than investor sentiment, while favouring strategies which look to profit from market trends, as well as smaller, nimble managers.

Tim Gascoigne, who was global head of portfolio management at HSBC Alternative Investments Limited, and who ran the $2.4 billion (1.5 billion pounds) GH fund of hedge funds left last month, after global banking group decided to merge its discretionary and advisory businesses.

Fund of funds are finding it increasingly tough to compete in an environment where investors are unwilling to pay an extra layer of fees. I happen to think that only the best funds of funds will survive the coming shakeout in the hedge fund industry, those that are able to add value in portfolio construction and identify new and existing talent.

And there are plenty of opportunities to seed emerging hedge funds. Bloomberg reports that Mike Stewart, who JPMorgan (JPM) Chase & Co. picked last year to oversee a unit of traders being moved out of its investment bank, has left to start a hedge fund.

Finally, Azam Ahmed of Dealbook wrote an excellent comment on Texas Teachers’ investment into Bridgewater. I quote the following:

If Bridgewater’s assets, and returns, continue to soar, the pension could do quite well. But if it has a string of bad years and investors withdraw their money, inflows could suffer.

“The investor has huge market risk,” said George J. Mazin, a partner at Dechert, a global law firm. “There have been a number of deals where investors bought high at the top of the market and in the next couple of years there was no growth and an attrition in assets.”

Such investments have been a mixed bag over the years.

Goldman Sachs, which started an in-house group to buy hedge fund stakes, has made some smart bets. Goldman’s Petershill fund bought a piece of Winton Capital in 2007 when the firm had less than $10 billion under management. Since then, its assets have swelled to nearly $29 billion, and performance has been strong, including a 6 percent return in 2011.

But Goldman has also had prominent losses. The Petershill fund bought a stake in Shumway Capital Partners not long before the firm’s founder decided to shut it down and return capital to investors. Another holding, Level Global Investors, was swept up in an insider trading investigation and decided to close shortly thereafter. Goldman lost big on its investment.

Morgan Stanley offers another cautionary tale. In 2006, it bought FrontPoint Partners, a hedge fund firm with $5.5 billion in assets. But soon, top managers started to leave. The relationship worsened when a FrontPoint manager was accused of insider trading in 2010.

In 2010, Morgan Stanley took a $193 million impairment charge related to FrontPoint. The bank sold its stake back to FrontPoint last year.

The deals can also prove treacherous for the hedge funds, as they try to navigate the relationships with their partners and their investors. An owner, like the Texas pension, may want fund assets to grow, because it means more money in hand. But an investor in the fund may want to keep a lid on the size, fearful that if the fund gets too large it will hurt performance.

I think Texas Teachers’ went overboard with this investment and time will prove me right. The landscape is changing in the hedge fund world. Investors fixated on the ‘old model’, chasing after the latest ‘superstar manager’, are going to be sorely disappointed. Those taking intelligent risks, changing without regret, will come out ahead.

Below, Bloomberg’s Dominic Chu reports that John Paulson lost 1.5 percent in February in one of his largest hedge funds, according to an investor update, paring this year’s gain and setting back efforts by the New York-based manager to recoup record losses in 2011. He speaks on Bloomberg Television’s “Inside Track.”

Also, Anita Nemes, Deutsche Bank AG’s London-based global head of capital introduction, talks about the outlook for the hedge-fund industry. Global hedge fund assets may rise 12 percent this year to a record $2.26 trillion as investors reduce cash and seek returns, according to an annual survey of investors by Deutsche Bank. Nemes speaks with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “InsideTrack.”

Tags: Bank Of America, Billionaire, Composite Index, Credit Crisis, Forbes Reports, Fund Business, Hedge Fund Performance, Hedge Funds, Investment Advisor, John Paulson, Losing Faith, Massive Amounts, Merrill Lynch, Outflow, Rd Quarter, Redemptions, Terrible Year, Trimtabs, U S Stock Market, Vardi
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Everybody’s Unhappy!? (Saut)

Wednesday, January 25th, 2012

Everybody’s Unhappy!?

by Jeffrey Saut, Chief Investment Strategist, Raymond James

January 23, 2012

“Money managers are unhappy because 70% of them are lagging the S&P 500. Economists are unhappy because they do not know what to believe: this month’s forecast of a strong economy or last month’s forecast of a weak economy. Technicians are unhappy because the market refuses to correct and gets more and more extended. Foreigners are unhappy because due to their underinvested status in the U.S. they have missed a big double play: a big currency move plus a big stock market move. The public is unhappy because they just plain missed out on the party after being scared into cash. It almost seems ungrateful for so many to be unhappy about a market that has done so well. Unhappy people would prefer the market to correct to allow them to buy and feel happy, which is just the reason for a further rise? Frustrating the majority is the market’s primary goal.”

… Bob Farrell, Merrill Lynch; September 1989

The bears are unhappy since the Santa rally, which began last Thanksgiving, has given the short-sellers no comfortable place to cover their shorts. Last week the bears suffered even more angst as most of the indices I follow tagged new reaction highs. The upside skein from the December 19th “low” has left the senior index better by ~8.1%, and up an eye-popping 13.3% since Thanksgiving. Counting the trading days from that mid-December “low” shows the rally has now encompassed 21 sessions with no more than a 1 – 3 session pause and/or correction. That makes this a fairly long of tooth “buying stampede.” Recall, buying-stampedes typically last 17 – 25 sessions, with only 1-3 session pauses/corrections along the way, before they exhaust themselves on the upside. It just seems to be the rhythm of the “thing” in that it takes that long to get participants bullish enough to throw in the towel and “buy ‘em” right before the markets peak and have a downside correction. Moreover, during the current stampede just about everything has been “run,” including all the sectors punctuated by the Banks +11.6% performance YTD. Accordingly, the only thing missing for a short-term “top” is a final burst to the upside driven by short-covering. My sense is this will occur into tomorrow night’s State of the Union address, which should be followed by a post address letdown for the stock market.

To be sure, the recent rally has not been accompanied by a noticeable increase in Buying Demand as measured by Lowry’s Buying Power Index. Rather the rally has occurred more from a reduction in Selling, which is reflected in Lowry’s Selling Pressure Index. Then too, the percentage of stocks above their respective 10-day moving averages (DMAs) has failed to confirm the upside and the New High list is not expanding. In fact, 40% of my short-term indicators are now bearish and none are bullish. Meanwhile, the NYSE McClellan Oscillator is overbought, the stock market does not have much internal energy left for a big rally, the S&P 500 (SPX/1315.38) is three standard deviations above its 20-DMA, the Volatility Index (VIX/18.28) is telegraphing too much complacency, and we have negative seasonality for the next few weeks. Nevertheless, I continue to think it is a mistake to get too bearish because I believe any pullback in the various indices will be contained.

My bullishness was reinforced last week during a conversation with Frederick “Shad” Rowe, the sagacious general partner of Dallas-based Greenbrier Partners. Summing the conversation, we decided the world is becoming richer faster than debt is expanding. This is not an unimportant point since everyone seems to be focusing on the “debt bomb,” which likely means it is the wrong question. Clearly, some folks are living above their means, some below, but many are living within their means, which can be seen in the Household Debt Service Ratio chart that is plumbing generational lows. Manifestly, the world is getting more prosperous and is producing more for less driven by technology. Truly, it is “one world” and we should start thinking of the U.S. as a state within that “one world.” This view is plainly stated in Federal Express’ annual report. To wit:

“We’ve reached a tipping point in how the world works. The largest economy in the world is no longer the economy of any one country – it’s the economy of global trade of goods and services. Value: $18.3 trillion in 2010. At FedEx, our job is to facilitate these transactions, the heart of commerce, by providing access – moving goods across the global supply chain.”

Or, how about this from Google’s annual report:

“Google is a global technology leader focused on improving the ways people connect with information. We aspire to build products that improve the lives of billions of people globally. Our Mission is to organize the world’s information and make it universally accessible and useful.”

One world indeed and there are actually a lot of good things happening. While the world is still a violent place, it is becoming less so as the wars we have been fighting come to an end. Additionally, the U.S. finally appears to be heading down the road of energy self-sufficiency, which should increase employment, and the U.S. dollar is currently the least unattractive currency in the world. Furthermore, as scribed in previous reports, there is a huge hidden layer of the U.S. economy that is becoming the engine of growth and wealth creation; and, this hidden layer is misrepresented in corporate financial reports. Surprisingly, the equity markets appear to value this hidden layer at approximately zero suggesting huge opportunity for investors to profit. The hidden layer referenced is Organizational Capital and Knowledge Capital, both of which reside under the macro moniker – Intangible Capital – so often mentioned in these missives. As the astute GaveKal organization writes:

“When we account for intangibles the picture of the U.S. economy changes. It is revealed that we are saving more and investing more than we thought. This means our economy is much more dynamic than we thought. This result is relevant in view of the perception of a low rate of saving in the U.S. economy, particularly because existing measures exclude much of the investment in knowledge capital that is a defining feature of the modern U.S. economy. … Validating intangibles is the key to eliminating the guesswork in valuing a company correctly. Indeed, this ‘new view’ of intangibles suggests they are the missing link between financial accounting and financial valuation.”

These observations, taken in concert amid the backdrop of a world that is profoundly underinvested in U.S. equities, continues to leave me walking on the “sunny side” of Wall Street even though in the very short term I am looking for a trading peak. During the envisioned decline investors should consider companies playing to the Intangible Capital theme. While participants should study all investment situations for themselves, some names for your consideration from our research universe playing to the Intangible Capital theme, and favorably rated by our fundamental analysts, include: Micron (MU/$7.76/Strong Buy), Analog Devices (ADI/$39.78/Strong Buy), Maxim Integrated Products (MXIM/27.83/Outperform), Texas Instruments (TXN/$33.64/Outperform), Xilinx (XLNX/$35.77/Outperform), Nuance (NUAN/$29.08/Strong Buy), Google (GOOG/$585.99/Outperform), Delta Air (DAL/$9.41/Outperform), and Urban Outfitters (URBN/$25.40/Outperform). Of course there is a way to purchase all of these companies that are accumulators of Intangible Capital (and more) via the GaveKal Platform Company Fund (GAVIX/$11.18).

The call for this week: Last Thanksgiving I suggested the Santa rally was beginning. I stuck with that “call” into the new year. On January 3, 2012 I stated that session felt like an “emotional peak” and that January 10, 2012 felt like the “price peak.” Subsequently I wrote, “The only question in my mind is if the markets are going to have a pullback into the 1230 – 1240 support zone, or go sideways to correct their overbought condition and allow the internal energy to be rebuilt.” So far, it has been a sideways consolidation until last week’s upside breakout causing one old Wall Street wag to exclaim, “Breakout or fake-out?!” On a short-term basis I think it is a fake-out believing a trading top is due this week …

Tags: Bears, Bob Farrell, Chief Investment Strategist, Comfortable Place, Double Play, Economists, Foreigners, jeffrey saut, Market Move, Merrill Lynch, Money Managers, Rally, Raymond James, Rhythm, Short Sellers, Skein, Stampede, Stock Market, Thanksgiving, Unhappy People
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Bob Farrell’s Ten Rules for Investing

Tuesday, January 3rd, 2012

Wall Street “gurus” come and go, but in the case of Bob Farrell legendary status was achieved. He spent several decades as chief stock market analyst at Merrill Lynch & Co. and had a front-row seat at the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987 crash.

3. There are no new eras – excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots.

As the fever builds, a chorus of “this time it’s different” will be heard, even if those exact words are never used. And of course, it – human nature – is never different.

8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend

Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

10. Bull markets are more fun than bear markets
Especially if you are long only or mandated to be fully invested. Those with more flexible charters might squeak out a smile or two here and there.

Sources: The Big Picture, 17 August, 2008 and MarketWatch, June 11, 2008.

Tags: Bear Market, Bob Farrell, Eras, Euphoria, Exact Words, Excesses, Heat Of The Moment, Juncture, Legendary Status, Merrill Lynch, Mid 1980s, Minded Investors, Overshoot, Pessimism, Row Seat, Rubber String, Stock Market Analyst, Stock Markets, Wall Street Gurus, Words Of Wisdom
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The Joy of Cooking (Saut)

Monday, November 21st, 2011

“The Joy of Cooking”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

November 21, 2011

Directions: In a large bowl, combine the following contents with a hugely confused investor population. Toss lightly. Just before roasting the turkey, spoon ingredients loosely into the body cavity of the turkey and do not overstuff. Truss all the opening so that no investors can escape. Use skewers if necessary.

Ingredients: Bread crumbs, watered down stock, enriched money supply, artificially low interest rates, depreciating currencies, malted securities, financial sausage, derivative yeast to increase expansion, roasted European chestnuts, governmental regulations to retard spoilage, and unelected czars to further enhance the mixture.

Selecting the Turkey: When it comes time to pick out the bird, we always remember the old stock market “saw” about poker games. In every poker game there is always a loser, also known as the “turkey.” If you have been playing poker for over 30 minutes, and you haven’t figured out who is the turkey, YOU are likely the turkey!

Stuffing the Bird: Always wait to stuff the bird until just before roasting. This may not be convenient, but it is by far the safest procedure. Fill the bird only about three quarters full, since the stuffing assuredly will expand.

Roasting: In timing the meat, remember that many factors are involved. The age of the bird, how fat it is and whether it is fresh. Generally the bigger the bird the longer it takes to cook. Keep in mind that all parts of the bird do not cook at the same time. We suggest a thermometer to test when it is done.

So wrote our dear departed friend, Stanley D. Salvigsen, decades ago from his perch as president of Comstock Partners. Stan began his investment career in 1964 as an analyst with the Value Line Investment Survey. Subsequently, he was an equity strategist at a succession of firms, including Dreyfus, Oppenheimer, C. J. Lawrence, and Merrill Lynch. Stan wrote the most engaging, entertaining, colorful, and insightful strategy reports I have read in my 41 years in this business. Select titles of his reports were: “That Ain’t Mud on Your Boots Partner,” “Revenge of the Nerds,” “Homesick,” and my favorite “Surf’s Up!” “Surf’s Up” showed pictures of a plethora of landside observers watching the few daring surfers willing to brave the 40-foot waves of Waimea Bay. Stan likened those surfers to the investors who had the courage to buy stocks in the summer of 1982 and ride the “big bull waves” that were likely going to occur as interest rates declined from 22%. It was a tempestuous time when my pleas to investors to buy stocks fell on deaf ears as their mantra was, “Why should I buy stocks when I can get 22% in a money market?” My response was, “That’s exactly why you should buy stocks!” Stan died of a heart attack in 1996 at the tender age of 53 in the offices of one of his best friends. Truly, a Wall Street icon who is still missed by many for his keen-sighted strategy reports.

Last week another Wall Street icon “fell,” but this time not because of death. Rather, Legg Mason’s Bill Miller “fell” due to market hubris. I worshiped Bill Miller’s prose from Richmond, Virginia until I moved to Baltimore and met him in the early 1990s. In subsequent meetings I found that his investment philosophy consisted of, “The man with the last dollar wins.” The idea was that if you average down in a declining stock, provided it’s not Enron-like, you inevitably “win” when that stock bottoms and rallies. Of course that strategy worked during the 18-year secular bull market that began in the summer of 1982 . . . until it didn’t.

Interestingly, in 1982 Bill Miller inherited Legg Mason’s Value Trust (LMVTX/$36.09) from another portfolio manager named Ernie Kiehne. “Keen Ernie’s” investment style was to watch companies with large revenues and then buy their shares when the net margins began to expand. That style left Ernie with large holdings in companies like supermarkets, which didn’t really “work” in the early 1980s and therefore he was removed from command of the fund. Enter Bill Miller at the start of the great bull market that began in the summer of 1982. Yet, while brilliant, Miller was anything but a value investor, often preferring growth stocks like AOL (AOL/$14.73) over value stocks. Plainly, that strategy also worked until it didn’t. Subsequently, he gave back all of his years of outperformance in the 2007 – 2009 debacle. To be sure, the strategy of “The man with the last dollar wins” collapsed in that decline, which lopped ~58% off of the S&P 500 (SPX/1215.65).

I revisit the Bill Miller saga this morning not to kick a man when he is down, but to reinforce the quote from the book “The Intelligent Investor” where Benjamin Graham tells us, “The essence of investment management is the management of risks, not the management of returns. All good portfolio management begins [and ends] with this tenet!” Clearly, Bill Miller deviated from that tenet as he rode many of his investments to substantial losses. Last week, such losses were pointed out to me by a Raymond James Financial Advisor who “pinged” me with the question, “Hey Jeff, we bought NII Holdings (NIHD/$23.41/Strong Buy), based on your recommendation, around $40.00 and we are now down some 50% in those investments. What’s the story?” After giving our fundamental analyst’s response that NIHD collects its revenues in the Brazilian currency, but reports its earnings in U.S. Dollars; and, that the rally in the U.S.$, vis-à-vis the Brazilian Real has really hurt NII’s earnings. Then I reminded my emailer that since the first Dow Theory “sell signal,” of September 1999, I have been adamant about not letting ANYTHING go more than 15% – 20% against you. That doesn’t mean I always sell a position at down 15% – 20%, but at that “uncle point” I take some kind of action. Sometimes it is to sell, other times it is to hedge the position to prevent the “Big Loss.” Indeed, the essence of investment management is management of risks, not the management of returns!

Another investment position I have recently been queried about is EV Energy Partners (EVEP/$65.27/Strong Buy), which over the past few weeks has declined from $78 per share into last Friday’s closing price of $65.27. There are some reasons for the decline. Firstly, and most importantly, rumors are swirling that the Obama administration is stopping energy operations in the Utica Shale Basin for environmental reasons. This is not true! What did happen was the Obama administration stopped new land leasing in the Utica for environmental reasons. Yet, the companies that already own mineral rights should still be able to drill. Secondly, a lot of “hot money” had piled into EVEP in anticipation of a Chesapeake Energy (CHK/$24.33/Market Perform) joint venture (JV) announcement. When EVEP didn’t rally on that announcement, the “hot money” sold. Consequently, there is no near-term catalyst for EVEP. The company’s drilling results in the Utica are likely months away. EVEP’s JV announcement isn’t due until 2H12 and then there is always the potential of a stock overhang. Operationally, however, our energy team doesn’t know of anything wrong.

The call for this week: Last Friday CNBC’s Maria Bartiromo asked me what was going to happen with this week’s Super Committee decision? After jokingly responding that if past is prelude if the Super Committee doesn’t arrive at a decision they will appoint a SuperDuper Committee, I then stated, “I don’t think the Super Committee will reach a consensus.” I also opined, “I believe there is a wink and a nod between President Obama and Speaker John Boehner to not implement the mandatory ‘cuts’ and let the 2012 Presidential election resolve the debate between increased taxes and spending cuts.” Quite frankly, I don’t know of any member of Congress that will stand for major military base closings in his (or her) state. Meanwhile, earnings continue to surprise with S&P 500 earnings up ~22% y/y, while revenues improved ~11.7% y/y. Such reports make it increasingly uncomfortable for the underinvested crowd; and the world remains profoundly underinvested in U.S. equities. Accordingly, I think stocks will continue to grind higher, provided we don’t talk ourselves into a recession. The reasons for that view are: 1) underinvested portfolio managers playing “catch up” (read: performance anxiety); 2) the upside seasonal bias; 3) low stock valuations; 4) improving economic trends; 5) still depressed sentiment readings; and 6) the knowledge that we have now entered the best performing six months of the year for stocks. Consistent with this view, I think the buying of inexpensive beta makes sense. To parse that theme, I screened our Analysts’ Current Favorites List, excluding the banks, looking for companies with less than an 18x P/E multiple (based on forward earnings estimates) and with more than a 1.20 Beta. Then I overlaid my proprietary technical algorithms and came away with the following names, all of which are rated Strong Buy by our fundamental analysts: Energy XII (EXXI/$30.25); National Oilwell Varco (NOV/$67.50); VeriFone (PAY/$42.97); and ValueClick (VCLK/$16.07), which I offer for your consideration. Regrettably, the SPX has violated my long-standing pivot point of 1217, bringing into view 1206 and then 1191; and while it was not “decisive” as of last week, it looks like it is going to be decisive this morning. The approximate cause for this morning’s futures fade is our dysfunctional government punctuated by the Super Committee’s failure to reach a decision. On the positive side, there is a “ton” of internal energy that has been rebuilt over the past few weeks following our near-term overbought “cautionary call” of 10/29/11 in a report titled “Crescendo.” Additionally, if the equity markets open where the futures are indicating, the McClellan Oscillator should be in oversold territory, as can be seen in the chart on page 3.

Click here to enlarge

Tags: Body Cavity, Chief Investment Strategist, Czars, Departed Friend, European Chestnuts, Governmental Regulations, Investment Career, jeffrey saut, Joy Of Cooking, Low Interest Rates, Merrill Lynch, Money Supply, Necessary Ingredients, Playing Poker, Poker Game, Poker Games, Spoilage, Three Quarters, Value Line, Value Line Investment Survey
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David Rosenberg in Depth – Are We In a Recession?

Wednesday, November 16th, 2011

This week on Wealthtrack, Consuelo Mack interviews one of the few economists to foresee the global economic slowdown. Gluskin Sheff’s David Rosenberg saw signs of trouble as chief economist at Merrill Lynch. Now back in his native Canada at Gluskin Sheff he continues to warn about a prolonged slump with high unemployment in the developed world. He discusses what it means for investors and where to find growth despite a stagnant U.S. and Europe.

Source: Wealthtrack, November 11, 2011.

Tags: Chief Economist, Consuelo Mack, David Rosenberg, Economists, Europe, Global Economic Slowdown, Investors, Merrill Lynch, Native Canada, November 11, Recession, S David, Sheff, Signs Of Trouble, Slump, Unemployment, Wealthtrack
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Bloomberg: Bonds Beat Stocks Over Past 30 Years, First Time That’s Happened Since Civil War

Tuesday, November 1st, 2011

If we need any evidence the past thirty years, especially the past twelve or so, have been horrid for investors, this Bloomberg article notes that (government) bond returns have actually beaten stock returns over thirty years. Ouch. They say stocks win out in the ‘long run’ but for the average person’s life span, you don’t want to go out forty years to get a superior return. Obviously this is very atypical – it’s the first time it has happened since the Civil War time frame!

To be fair, yields were very high on government bonds in the early 80s/late 70s as Paul Volcker was fighting off inflation so the starting point for prices was quite low in a relative sense (prices low, yields high), but it’s still an amazing statistic.

Just more evidence we should never stop QE’ing – QE for 30 years and more artificial returns will make us all mad money!

The biggest bond gains in almost a decade have pushed returns on Treasuries above stocks over the past 30 years, the first time that’s happened since before the Civil War.
Fixed-income investments advanced 6.25 percent this year, almost triple the 2.18 percent rise in the Standard & Poor’s 500 Index through last week, according to Bank of America Merrill Lynch indexes. Debt markets are on track to return 7.63 percent this year, the most since 2002, the data show. Long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.
The combination of a core U.S. inflation rate that has averaged 1.5 percent this year, the Federal Reserve’s decision to keep its target interest rate for overnight loans between banks near zero through 2013, slower economic growth and the highest savings rate since the global credit crisis have made bonds the best assets to own this year. Not only have bonds knocked stocks from their perch as the dominant long-term investment, their returns proved everyone from Bill Gross to Meredith Whitney and Nassim Nicholas Taleb wrong.
“The generation-long outperformance of bonds over stocks has been the biggest investment theme that everyone has just gotten plain wrong,” Bianco said in an Oct. 26 telephone interview. “It’s such an ingrained idea in everyone’s head that such low yields should be shunned in favor of stocks, that no one wants to disrupt the idea, never mind the fact that it has been off.”
Stocks had risen more than bonds over every 30-year period from 1861, according to Jeremy Siegel, a finance professor at the University of Pennsylvania’s Wharton School in Philadelphia, until the period ending in Sept 30. The last time was in 1861, leading into the Civil War, when the U.S was moving from farm to factory, according to Siegel, author of the 1994 book “Stocks for the Long Run,” in a telephone interview Oct. 25.
U.S. government debt is up 7.23 percent this year, according to Bank of America Merrill Lynch’s U.S Master Treasury index. Municipal securities have returned 8.17 percent, corporate notes have gained 6.24 percent and mortgage bonds have risen 5.11 percent. The S&P GSCI index of 24 commodities has returned 0.25 percent.

Tags: Article Notes, Bank Of America, Bianco Research, Bond Returns, Bonds, Civil War Time, Commodities, Credit Crisis, Debt Markets, Fixed Income Investments, Global Credit, Government Bonds, Inflation Rate, Jim Bianco, Life Span, Mad Money, Merrill Lynch, Overnight Loans, Paul Volcker, Relative Sense, Stock Returns, Three Decades
Posted in Bonds, Brazil, Commodities, Markets | Comments Off

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