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Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | April 27, 2017

Back To School

By: Mark M. Green, CFA, Chief Investment Officer and Oxford Investment Fellow


Back To School

"Price is what you pay; value is what you get."
– Ben Graham

"In investing, what is comfortable is rarely profitable."
– Rob Arnott

"The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions."
– Seth Klarman

"The shoe that fits one person pinches another; there is no recipe for living that suits all cases."
- Carl Jung

Careful readers of the Investment e.Perspective may have noticed certain recurring themes in recent months. First, we've spent a lot of time discussing various elements of our investment philosophy, including articles and videos outlining what we refer to as our Core Principles. Two of those Core Principles "No one can predict the future; Investment decisions should be a function of value and risk" and "If it's obvious, be skeptical; If it feels uncomfortable, you may be on to something" are captured directly in the quotes above by Ben Graham and Rob Arnott.

A second theme has focused on Behavioral Finance and the role of psychology, emotion and cognitive bias in investment decision making. Again, we have developed articles and videos on these topics, highlighting another Core Principle, "Human emotions (greed, fear, panic) will always create opportunities for the disciplined." Seth Klarman sums it up pretty well, in the quote attributed to him, though the concept obviously goes far beyond the stock market alone.

Finally, we have hammered away consistently at the idea that all investment decisions need to be made within the context of well-conceived investment policy. A plan. Our very first Core Principle states: "Success begins with a long-term plan and ends with the failure to follow it." And, as Carl Jung implies, there is no recipe that suits all investors. Financial goals, objectives, aspirations and constraints can be quite different from one investor to the next. Investment policies and portfolios should be constructed appropriately.

Why reiterate these themes and Core Principles now? Well, summer is over and it's back to school. Time to remember the basic lessons. We just drifted through a period of low volatility, low volume and record highs for US stock indices. Can such blissful market conditions last? We think it is unlikely. There is a lot coming at us in the months ahead and investors need to be comfortable with the way their portfolios are positioned. For example:

  • The Fed just concluded its September meeting of the Federal Open Market Committee, demurring again on tightening policy but heightening expectations for a move in December – a full year after the much ballyhooed "Lift Off" of interest rate increases. But who can blame them for wanting to get past November before pulling the trigger? After all, they've waited this long and it isn't as though their economic projections are really that precise. Yet, they've painted themselves into a tight little corner with their forward guidance and their "dot plots" and their efforts to talk up inflation expectations. The Fed's "credibility" is now on the line and – right or wrong – there is a growing sentiment among analysts that the longer they wait the more they'll have to do. Turning points in monetary policy cycles are always accompanied by increased market volatility and there is absolutely no reason to believe this time will be any different.
  • The third quarter "earnings season" kicks off in early October. We have had five consecutive quarters of year-over-year declines in operating earnings for S&P 500 companies, and Q3 2016 may well mark the sixth. In many ways, the current earnings "recession" reflects many of the economic fundamentals that have kept the Fed on hold for so long – sluggish growth in final demand, declining labor productivity in a tightening labor market and a lack of pricing power. Weak earnings only underscores the valuation concerns regarding equities, especially in the US, at least for long-term investors who focus on value, price and risk. For those with shorter-term perspectives, managing strictly against a benchmark or willing to speculate in the market, valuation is less of a consideration. Some of these investors follow the "Greater Fool" theory and depend on someone else to pay even higher prices for their assets in the future. Momentum strategies often fail at turning points in market cycles.
  • The November general election is fast approaching, featuring two of the most disliked and distrusted presidential candidates in US history. Many Americans alternate between feelings of dread, nausea and profound disappointment at the choice before us. Nobody wants to believe this is really the best America can do, and yet here we are. Split tickets? Long coat tails? How will the House and Senate shake out? Who knows?! The polls are all pretty close and we may cast our fate to the wind, literally, as the outcome might well depend upon the weather and voter turnout on election day. Presidential election cycles often affect the financial markets and while the directional impact is difficult to predict increased volatility is not uncommon.

We likely have three major cycles turning simultaneously, any one of which could upset the apple cart in significant ways. Reviewing goals and objectives, reminding ourselves of basic lessons and remaining true to our Core Principles seems like a prudent thing to do. While a lot of mainstream strategies look tired and vulnerable, we believe there are still many opportunities in the capital markets in niche strategies, some of which may feel uncomfortable. But that is where value is often found.

Elsewhere in the Investment e.Perspective this month are two articles focusing on different segments of the capital markets. Jim Mahoney pokes a little tongue-in-cheek fun at Federal Reserve Board Chair Janet Yellen and her imaginary friend TINA (an acronym for There Is No Alternative). One consequence of the extraordinary monetary policy measures undertaken by the Fed and other central banks has been the rise in valuation of risk assets (especially global stocks and even more especially US equities), as the returns available in safety assets (bonds) have declined. At the same time, one consequence of the change in regulatory oversight of the banking industry has been the void created in the credit market, as banks have backed away from certain types of lending activities. Jim's point is that there really ARE alternatives to traditional risk assets, for those who are willing to invest in certain types of niche strategies. One of these strategies is in the specialty finance sector, where non-bank lenders fill the void left by the traditional banking industry.

Jared Nishida takes a clinical look at various Real Asset strategies, including real estate, energy infrastructure, inflation protected bonds and commodities/natural resources. Some of these strategies have undergone extreme down-side volatility in recent quarters. Jared includes an absolutely eye-popping chart showing the divergence between the equity prices of publicly listed REITs and natural resource producing companies. Their common element of inflation protection hasn't provided much benefit in the current low-inflation world, but the yields attached to some of these investments are attractive to income-oriented investors. Moreover, for investors with long-term horizons the risk / reward profile of these strategies offers significant upside potential.

The above commentary represent the opinions of the authors as of 9.29.16 and are subject to change at any time due to market or economic conditions or other factors.