My partner, Michael Lebowitz, penned an excellent piece this week on valuations and long-term returns. I highly suggest reading the entirety of the article, but here is the crucial point. “Regardless of the economic environment, taking significant risks, and accepting pitiful expected returns is a bad idea. The average of the 10-year expected returns from the four gauges is -0.75%. When the Fed backs off, whether by its design or due to inflation, slower economic growth, or massive debt overhead, rich valuations will matter.” “The NYSE is the only place in the world that when the sign says ‘Everyday high prices’, everyone gets excited. If Walmart had the same sign, instead of ‘Everyday low prices’, no one would show up.” – Peter Boockvar Running With The Herd As we have stated,
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My partner, Michael Lebowitz, penned an excellent piece this week on valuations and long-term returns. I highly suggest reading the entirety of the article, but here is the crucial point.
“Regardless of the economic environment, taking significant risks, and accepting pitiful expected returns is a bad idea. The average of the 10-year expected returns from the four gauges is -0.75%. When the Fed backs off, whether by its design or due to inflation, slower economic growth, or massive debt overhead, rich valuations will matter.”
“The NYSE is the only place in the world that when the sign says ‘Everyday high prices’, everyone gets excited. If Walmart had the same sign, instead of ‘Everyday low prices’, no one would show up.” – Peter Boockvar
Running With The Herd
As we have stated, “valuations” are a terrible “market timing” indicator. However, valuations tell you everything you need to know about future returns. It is about “sentiment” and “herd psychology” more than anything else in the very short-term.
As my colleague, Doug Kass observed on Thursday in his “Real Money Diary.”
‘Time and time again traders and investors robotically and often emotionally follow price and ignore the simple notion that higher stock prices are the enemy of the rational buyer and lower prices are the ally of the rational buyer.
Too often as stock prices rise, investors cheer and commonly ignore the consequences of buying at a high and elevated entry price.
And, too often as stock prices drop, investors panic and commonly ignore the consequences of selling at a low and depressed exit price.
Thanks to a changing market structure, where active investing is overwhelmed by passive investing, mentalities have changed. Such also helps explain the popularity and proliferation of exchange-traded funds, quant strategies, and products that worship at the altar of price momentum. In its essence, ‘buyers live higher and sellers live lower.’
This evolution in market structure has arguably resulted in the least informed investor base in history as machines and exchange-traded funds know nothing about price and everything about value.”
The problem is volatility has become a “wicked master.” As we saw in March, the “elevator down” can come swiftly. With investors piling into ETFs, and algorithmic quant strategies chasing momentum, markets will be more susceptible to wild future swings. When investors and robots try to “exit the theater” simultaneously, the drops will be swift with little notice.
Portfolio Positioning Update
Last Monday, just after Moderna made their vaccine announcement, I tweeted:
Our job is to adjust our allocations to capture profits and protect capital when the “risk/reward” profile becomes unbalanced. On Monday, we reduced our exposure by increasing our bond holdings last Wednesday and raising cash levels Monday. Such was the point I made Tuesday in our “3-Minutes” video.
A Catalyst For A Decline
When markets are incredibly exuberant and extended, all that is needed to spark a short-term corrective process is a “catalyst.”
Following Thanksgiving and into the first two weeks of December, mutual funds must distribute their capital gains and interest for the year. As shown below, fund managers are carrying some of the lowest cash balances on record; we could see selling pressure to make distributions.
We Play The Probabilities
While many will read this article as being “bearish,” it isn’t.
As portfolio managers, we manage the risk of capital loss against the potential for reward. In other words, we “we prepare for the probabilities, but leave room to adjust for the possibilities.”
No one knows with certainty what the future holds, which is why we must manage portfolio risk accordingly and be prepared to react when conditions change.
I am neither bullish nor bearish. I follow a straightforward set of rules that are the core of our portfolio management philosophy. We focus on capital preservation and long-term “risk-adjusted” returns. Importantly, no discipline is perfect. Nothing works “all the time.”
However, any discipline or strategy works better than “no strategy at all.”
Everyone approaches money management differently.
Such is just the way we do it.
If you need help or have questions, we are always glad to help. Just email me.
See You Next Week
By Lance Roberts, CIO
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