Being in the investment arena, our job is mostly about gathering information. Reading. Lots and lots of reading. Corporate reports, sell-side research, blogs, websites, financial journals, and the like. We have our favorite sources and investors. If you have read our notes for any length of time, you know that we read anything that we can get our hands on that Howard Marks has written. Mr. Marks’ latest note is out this week. Marks doesn’t write every week or even on a consistent basis, but when he writes, he has something to say and he envelopes everything he writes with priceless investing wisdom. If you are a serious investor, you must read the whole piece. I am having trouble just boiling it down to a few well-turned phrases or sound bites but here goes.
As I explained on CNBC, there are two things I would never say when referring to the market: “get out” and “it’s time.” I’m not that smart, and I’m never that sure.
“Investing is not black or white, in or out, risky or safe.” The key word is “calibrate.” The amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive.
If it’s true, as I believe, that (a) the easy money in this cycle has been made, (b) the world is a risky place, and (c) securities are priced high, then people should probably be taking less risk today than they did three, five or seven years ago. Not “out,” but “less risk” and “more caution.”
Marks mentions that he is not referring to this market as a “bubble”. He is probably right. There are no signs of euphoria (other than bit coin) but investors are begrudgingly going along with higher prices. It is more of a FOMO (Fear of Missing Out) mentality. Valuations are high and rising and “getting out” at the top is a pipe dream. Rather than jump in and jump out of the market, we seek to recalibrate our investment allocation in regards to the risk premium in the market. If prices are high, then we wish to take some risk off the table. We can put our money into investments that have less risk or place them with outside managers with a history of performing well in riskier markets. We can also choose to place more of our assets in cash which is essentially a call option on risk. We, like Marks, continue to proceed but with caution. “Calling a top” and “getting out” are a Fool’s Errand, but lessening our risk in light of historical valuations is a prudent thing to do.
In regards to risky behavior, we call your attention to something that we have seen for some time, over and over again, and it costs investors huge sums of money. This time around it is the sale of “Cat Bonds” to the small investor. Once the province of big money center banks and offshore insurance companies, “Cat Bonds” are catastrophe bonds sold by large reinsurance companies. The short story is you can make high yield returns by investing in bonds which insure against wind damage, hurricanes, earthquakes and other catastrophic events. Suffice to say that those investors after several years of decent returns will return to work on Monday with a lot less digits in those accounts. Those investors will be wiped out completely if Irma has her way with Florida this weekend. How do you spot these enemies to your portfolio the next time? It is easy. If someone promises you an above-average yield in a product that is unlisted (it does not trade on an exchange) with high management fees – run, do not walk away from this investment advisor. I have seen too many of these investments in investors’ portfolios in my time. The advisor ends up with his management fees and the client ends up with the goose egg.
When the pressure is on, we like to have what we term “adults” in the room. The “adults” are not only the smartest people in the room, but they are people who know how and when to make a decision. Stanley Fischer is one of those “adults.” Dr Fischer, former professor at MIT, vice chairman of Citi Group, and chief economist of the World Bank, and former Governor of the Bank of Israel, resigned his position as vice chair of the Federal Reserve. Fischer played the role of intelligent hawk who we felt comfortable leaving in charge of the store. As this critical time approaches of the Fed removing stimulus, his absence alone makes us less confident in the “adults” left in the room. In one of his last public speeches as part of the Federal Reserve, Dr. Fischer warned about historically high asset valuations.
Let me conclude my assessment of current financial stability conditions with a discussion of asset valuation pressures… In equity markets, price-to-earnings ratios now stand in the top quintiles of their historical distributions, while corporate bond spreads are near their post-crisis lows. …
The general rise in valuation pressures may be partly explained by a generally brighter economic outlook, but there are signs that risk appetite increased as well…So far, the evidently high risk appetite has not lead to increased leverage across the financial system, but close monitoring is warranted.
West Texas Crude has had some wild moves post Hurricane Harvey but is still stuck between $45 and $50 a barrel. The safe havens benefited this week as gold has sufficiently punched through $1,300, making that area now support. The 10-year Treasury which had been stuck between 2.15% and 2.40% since April finished the week at 2.05%, which could augur a price movement down into the 1.75-1.85% area. The move is on into the safe havens while stocks mystically continue to hold their gains and their range between 2,420 and 2,480. While the caution signs are there the market is still firmly in an uptrend. A punch through 2,480 on the S&P 500 could give the bulls room to run. The rally off of the lows has been anything but active. A low volume run up doesn’t bring with it much conviction, but the animal spirits could take over regardless with a swift punch through 2,480. The pressure is building.
Harvey was the story last week. This week it’s IRMA. Best of luck to all our friends and family in Florida. Hold on tight.