Tag: Value Investing

Traders Puzzled After Chinese Media Warning Triggers Market Selloff

Overnight we highlighted that despite a massive weekly net liquidity injection by the PBOC (which ended on Friday when the PBOC drained a net 10bn in liquidity) Chinese stocks failed to hold on to Thursday’s gains, and resumed their slump…


… headed for their worst week in 7 months.


However, it was more than the simply a question of liquidity flows, because it once again appears that Beijing is involved in micromanaging daily stock moves, only unlike the summer of 2015 when China blew a huge stock bubble in a few months, which then promptly burst leaving China scrambling for the next year to figure out how to avoid contagion, this time Xinhua had a different message: sell.

According to Bloomberg, the reason why Chinese stocks – led by Shenzhen shares – slumped on Friday, is due to a warning by state media that one of the nation’s hottest stocks was climbing too fast, which in turn triggered a selloff. And while the SHCOMP closed down 0.5%, the Shenzhen Composite Index closed down more than 2%, with liquor makers and technology companies that had outperformed this year among the biggest losers.

The catalyst that sparked the selloff? China’s biggest liquor maker, Kweichow Moutai, which plunged 3.9% – after tumbling as much as 5.8%, its largest decline since August 2015 – after Xinhua News Agency said its China’s biggest “should rise at a slower pace.” Other liquor makers fell in sympathy, Wuliangye Yibin slid as much as 5.3% in Shenzhen, the most since July 2016, and Luzhou Laojiao fell 4.7%, although the stocks, which have more than doubled this year, pared their losses by the close.

In commentary published in the state-owned newspaper, the author said “short-term speculation in Kweichow Moutai shares will hurt value investing and long-term investment will deliver best returns.”

The bizarre and unusual critique – traditionally China’s media mouthpieces have only urged stocks to go higher, never lower – capped a week that saw a rout in Chinese sovereign bonds spill into the equity market amid concern about a government deleveraging campaign and faster inflation. For the week, the Shenzhen gauge fell 4.2%, its worst loss since May 2016. The Shanghai benchmark declined 1.5 per cent.

“The Xinhua warning was the last straw,” said Ken Chen, a Shanghai-based analyst with KGI Securities Co. “Expectations of worsening liquidity conditions are also hurting stocks.”

In retrospect, perhaps the Xinhua warning was not so strange: after China’s debt-fueled stock market bubble burst in 2015, wiping out $5 trillion of value, Chinese policy makers have acted to restrain excessive speculation in equities.

Xinhua is concerned that a runaway rally in a heavyweight like Kweichow will hamper the stability of the overall market,” said Hao Hong, chief strategist at Bocom International Holding Co in Hong Kong.

And while one can wonder why China is suddenly so concerned about even the hint of potential vol spike in the stock market – suggesting that even a modest selloff could have dramatic consequences for the Chinese financial sector – it is certainly strange that whereas even China is acting to restrain the euphoria of its citizens over fears of what happens during the next bubble, in other “developed” countries, the local central bankers, politicians and TV pundits have no problem in forcing retail investors to go all risk assets when the market is at all time highs.

As for China, it will have truly gone a full “180”, if in a few months time instead of arresting sellers as it did in the summer of 2015, Beijing throw stock buyers in prison next.


Finnish Fund Manager Launches ‘Buffett-In-A-Box’ A.I.-Based Fund… There’s Just One Thing

Amid the empty-vessel-driven "deep-learning", "artificial-intelligence", and "algorithmic" narratives-du-jour, more and more fund managers are jumping on the bandwagon. The latest is Finnish fund manager FIM, who is introducing the first investment fund in the Nordic region, where a self-learning algorithm gets to pick all the stocks.

As Bloomberg reports, targeting returns of 3 percentage points above the MSCI World Index, the FIM Artificial Intelligence fund seeks to tease out patterns even an experienced fund manager may not detect, according to Chief Investment Officer Eelis Hein, who oversees 5.6 billion euros ($6.6 billion) in investments at FIM Asset Management.

“This is the next revolution across society, including in investing,” Hein said in an interview in Helsinki.


“Investors are hugely interested.”


The “Warren in a box” technology, referring to famous value investor Warren Buffett, is a product of more than two years of work by Acatis Investment GmbH and NNaisense SA, a Lugano, Switzerland-based developer of artificial intelligence.

That all sounds very exciting and 'new' and 'tech' and awesome. There's just one thing

Johnny-5 sucks at stock-picking…

Remember what that AI Fund CEO said… “EquBot AI Technology with Watson has the ability to mimic an army of equity research analysts working around the clock, 365 days a year, while removing human error and bias from the process.”

But hey FIM is not giving up, they drop some more complex words to 'splain away any potential doubts an investor may have…

“AI may detect non-linear patterns that traditional quantitative analysis is not able to identify,” Hein at FIM said.


“It has no emotions: it hasn’t felt fear during a crash nor euphoria when markets are up.”


Einhorn: “None Of The Problems From The Financial Crisis Have Been Solved”

A month ago, a downbeat David Einhorn exclaimed "will this market cycle never turn?"

Despite solid Q3 performance, Einhorn admitted that "the market remains very challenging for value investing strategies, as growth stocks have continued to outperform value stocks. The persistence of this dynamic leads to questions regarding whether value investing is a viable strategy. The knee-jerk instinct is to respond that when a proven strategy is so exceedingly out of favor that its viability is questioned, the cycle must be about to turn around. Unfortunately, we lack such clarity. After years of running into the wind, we are left with no sense stronger than, 'it will turn when it turns'."

Such an open-ended answer, however, is a problem for a fund which famously opened a basket of "internet shorts" several years prior, and which have continued to rip ever higher, detracting from Greenlight's overall performance.

This, in turn, has prompted Einhorn to consider the unthinkable alternative: "Might the cycle never turn?" In other words, is the market now permanently broken.

While the Greenlight founder did not explicitly answer the question, in a speech yesterday at The Oxford Union in England, Einhorn made it extremely clear just how farcical he believes this market, and world, has become, pointing out that the problems that caused the global financial crisis a decade ago still haven’t been resolved.

“Have we learned our lesson? It depends what the lesson was,” Einhorn, the co-founder of New York-based Greenlight Capital, said at the Oxford Union in England on Wednesday.

Infamous for his value investing style and bet against Lehman Brothers that paid off in the crisis, Bloomberg reports that Einhorn said he identified several issues at the time of the crisis, including the fact that institutions that could have gone under were deemed too big to fail.

The scarcity of major credit-rating agencies was and remains a factor, Einhorn said, while problems in the derivatives market “could have been dealt with differently," and in the “so-called structured-credit market, risk was transferred, but not really being transferred, and not properly valued.”

“If you took all of the obvious problems from the financial crisis, we kind of solved none of them,” Einhorn said to a packed room at Oxford University’s 194-year-old debating society.


Instead, the world “went the bailout route.”


“We sweep as much under the rug as we can and move on as quickly as we can,” he said.

Einhorn didn’t avoid discussing his underperformance, citing several failed bets that companies’ stocks would decline. He didn’t name the stocks he was shorting, but insisted that none of the companies are “viable businesses.”

Value investing has worked over time, but “it’s not working at all right now,” and in fact “the opposite seems to be working,” he said.

Greenlight remains focused on developed markets, and has no plans to change that, he said.

Which reminds us of his exasperated conclusions from the latest Greenlight letter to investors:

Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?


It’s clear that a number of companies provide products and services to customers that come with a subsidy from equity holders. And yet, on a mark-to-market basis, the equity holders are doing just fine.

Ah yes, the Fed-funded "deflation trade" which lowers prices for goods and services courtesy of ravenous investors who will throw money at any "growth" idea, without considerations for return or profit, because – well – more such investors will emerge tomorrow.  After all, in this day and age of ZIRP, what else will they do with their money.


The 12-Point List To Identify Value Traps

Submitted by Nick Colas of Datatrek Research

Poor, Poor Pitiful… Value Stocks

"Value trap". That’s a phrase we haven’t heard much in recent years, but GE seems to be bringing it back. And as we looked at the dramatic outperformance of growth stocks over value this year, it is clear that there are many such traps in US markets. Having covered the auto industry for a long time, we are well acquainted with the phenomenon. In today’s note: a 12-point list to help you identify value traps.

The outperformance of growth versus value investing in 2017 is dramatic. A few numbers to frame the discussion:

  • The Russell 1000 Growth Index is up 24.8% YTD, while its Value Index counterpart is only 6.3% higher on the year. Value underperformance: 1,850 basis points.
  • The Russell 2000 Growth index is up 15.7% YTD, but the Value Index version is only 2.1% higher. Value underperformance: 1,360 basis points.
  • The S&P 500 Growth Index is +22.5% on the year, but the Value Index for the 500 is up only 7.3%. Value underperformance: 1,520 basis points.

Any way you cut it, value is profoundly out of favor, and not just in 2017. While proponents of this style are typically patient people, the differential is large enough to be worrisome. Over the last 10 years, growth has outperformed value by more than 2:1.

This leads us to believe that there are a lot of “Value traps” out there – stocks that look cheap on valuation, but never substantially rebound. We got to thinking about this term when we saw it applied to GE today. And as we pulled the growth/value performance data, it became clear that the problem goes a lot deeper than just one company.

Simply put, the value side of the US equity market seems littered with traps. It’s not just GE. It is clearly a minefield out there in value land.

For better or worse, we have a lot of experience in identifying value traps from covering the auto industry for much our professional lives.

So (with apologies to Jeff Foxworthy), here is our list of “You might own a value trap if…”

#1 The company is at the peak of an operating cycle and is still troubled. After +7 years of economic recovery, most public companies should be showing peak earnings. If they are not, something else is wrong. One legitimate exception: commodity sector companies like oil and gas.

#2 Management compensation structures haven’t changed as the stock has declined or underperformed. The old adage “What gets measured gets managed” applies here. If earnings (and/or the stock price) have declined but management comp structures haven’t adapted to address that problem, fundamental changes of behavior in the C-suite are unlikely.

#3 The company or industry dominates a smaller US city. This one is deeply informed by my experience visiting Detroit every 90 days for a decade-plus. Managements have to live somewhere, and if that location is full of like-minded people then change is harder to execute. One GM chairman even thought of moving the company headquarters to Geneva in the early 1990s. It might have helped…

#4 The business keeps losing market share. Value traps often occur with companies that are losing out to new competition. Until market share trends higher, the stock seldom does.

#5 There are other powerful stakeholders. Back to the auto industry for an example. Unions can slow the pace of needed change, as can entire governments (see VW, which is partially owned by the German state where it is headquartered). If return on shareholder capital has to fight with other entrenched interests, the pace of change will be slower. Often, much slower.

#6 The capital allocation process isn’t changing fast enough or is unclear. The funny thing about many value traps is that they still have decent current free cash flow. The “Trap” comes from not using that capital efficiently to reinvigorate the business. By definition, the old ways of allocating capital don’t work any more. So what is management doing differently, and how is that change outlined to shareholders?

#7 The company isn’t changing how it evaluates line managers. This one is deep in the weeds, but it is important. For a company to escape “Value trap” status it has to change its operational DNA. And that means pushing those changes down to the operating level where customers see the difference.

#8 Management’s near term goals are not achievable, and/or they have failed at the majority of prior year goals. Value stocks “Work” when operational results improve according to a predetermined management plan. That’s when investors start to build in a better valuation multiple. But if management sets out unrealistic goals, even modest improvement doesn’t get that bump. That’s why “Underpromise and overdeliver” is so important.

#9 The company has more leverage than it can sustain through a multi-year turnaround. Financial debt is the actual trigger for the most deadly value traps, snapping shut before management can turn things around. This can come in many forms, including working capital requirements, leases, and short term refinancing.

#10 The strategic vision is cloudy. Value traps almost always suffer from fuzzy management strategies. If the whole thing – financial analysis included – doesn’t fit on one page, it probably won’t work.

#11 The CEO and Chairperson of the Board are the same person. Ask any CEO how much time managing their board takes, and the number will likely be 25-40% of their day. Deeply entrenched value traps are by their nature corporate turnarounds, whether the boss realizes it or not. They need 100% of senior management attention.

#12 Even activist investors stay away. In the end, any good value story with non-lethal problems should attract activist shareholders. If it doesn’t, you can scratch an important catalyst off the list.

And finally, for those readers who spotted the Warren Zevon song lyric in the title, a link to the song’s more famous rendition by Linda Ronstadt: https://www.youtube.com/watch?v=Cd2_LKoTYKw


More New Normal – Buy Bloomberg’s “Bubblicious” Index Of Bubbles – Make Out Like A Bandit

If only every year was this “easy”.

Unfortunately, the old adage of the trend being your friend becomes harder to adhere to as a guidepost as one asset market after another goes into bubble territory. As we discussed here, Alberto Gallo of Algebris Investments has ranked (see here) the top 14 bubbles worldwide, according to characteristics such as duration, appreciation, valuation and the degree of irrational behaviour.

When we started in this industry, we were taught by those with the gray hair of experience that betting against the herd was the key to success. Turning up on January 1, imagine the look on their faces if you’d told them you’d bought a portfolio of everything that had gone parabolic (or almost) the previous year. Luckily for them, markets were relatively free and absent $15 trillion of price insenstive asset purchases by central banks. Fundamentals counted for somethiing – and will again (we hope) – there’s just the small matter of getting to the other side of the current bubble, sorry bubble(ssssssssssssssssssssssssssss).

In 2017, the strategy of buying bubbles has obviously worked almost perfectly or, as Bloomberg notes,“Investors can either buy bubbles or be left far behind”. Indeed, it’s gone to the trouble (see here) of creating ts own “Bubblicious” index, which includes an equal weighting of a host of the “usual suspects”. These include:

  • Sunac China Holdings Ltd.: perhaps the poster child of the real-estate frenzy in the world’s second-largest economy, this company’s aggressive acquisition strategy has been met with raised eyebrows among regulators at a time when China is trying to rein in the country’s financial risk.
  • Tencent Holdings Ltd.: A 2,600 percent rise in the past decade? Tencent is the leader of the pack when it comes to Asian tech stocks that have made the sector the biggest component of the MSCI Asia Pacific Index for the first time since the internet bubble.
  • Tesla Inc. and Netflix Inc.: two U.S. tech companies that have both been branded with the b-word by hedge fund manager Einhorn.
  • VelocityShares Daily Inverse VIX Short-Term ETN, ticker XIV: this exchange-traded note is a proxy for the presumed “short volatility” bubble that’s seen investors bet billions of dollars on the prospect of not much happening in markets.
  • Bitcoin Investment Trust, ticker GBTC: the cryptocurrency fund that typically trades at a substantial premium to its net asset value. Bitcoin itself has been called a bubble by bank CEOs including JP Morgan Chase & Co.’s Jamie Dimon, ethereum co-founder Joseph Lubin and many more.
  • ETF Industry Exposure & Financial Services ETF, ticker TETF: this meta exchange-traded product holds a basket of firms poised to benefit the most from the explosion in ETFs — a proxy for the “passive bubble.”
  • Lots of long bonds: The iShares 20+ Year Treasury Bond ETF has enjoyed $1.8 billion worth of inflows in a year that saw former Federal Reserve Chair Alan Greenspan warn of a massive bubble in the space. Meanwhile yields on German sovereign debt maturing in 2048 and Japanese bonds maturing in 2050 have dipped ever lower, sealing the latter’s reputation as a ‘widow maker’ for frustrated shorts. The portfolio also includes the infamous Argentinian century bond.

Bloomberg observes that its broad range of choices mean that its Bubblicious portfolio is “fairly well diversified” across the many bubbles. Actually, it could have been more diversified. While we don’t disagree with the inclusion of any of Bloomberg’s picks, it’s worth noting that compared with Gallo’s list, the Bubblicious portfolio does not include European high yield, EM high yield or any of the obvious property bubbles outside China. London, for example, and Australian cities, such as Sydney and Melbourne. Unlike Gallo, we might have chosen New Zealand property instead of London property (where prices have started falling) and, while Bloomberg has chosen Sunac as its “poster child” for Chinese real estate, China Evergrande and others would be equally valid.

Anyway, as Bloomberg explains, the “Bubblicious” index has risen by well more than 120% so far this year.

The best way to crush the crowd in 2017? Buy the things everyone insisted would never keep going up. A portfolio stuffed with allegedly over-inflated assets would have returned more than 120 percent so far in 2017, trouncing the S&P 500 Index and underscoring the challenge for investors facing a plethora of pricey securities.

As the chart shows, if you’d gone “Bubblicious” on 1 January 2017, you’d have smashed the S&P 500 "out of sight" by more than 100%.

As Bloomberg laments.

The hypothetical ‘Bubblicious’ portfolio includes Chinese real estate and internet names, a pair of U.S. tech behemoths, a cryptocurrency fund, the ETF industry, bonds that mature decades from now, and a dash of short volatility bets just to make things more interesting.


The out-performance is a testament to the momentum mania prevalent in today’s markets, a dynamic which has prompted the likes of Greenlight Capital’s David Einhorn, Goldman Sachs Group Inc., and Sanford C Bernstein & Co. LLC to mull whether value investing is in the midst of an existential crisis given ultra-low interest rates and abundant liquidity.

Of course it is, but the nature of markets is that they move in cycles. This cycle happens to be the most unpleasant cycle for value investors, active managers and contrarian thinkers, but it’s still a cycle.


‘Value Investing’ Deadpool

Authored by Kevin Muir via The Macro Tourist blog,

I sure hope Julian Robertson is a Ryan Reynolds fan. And although I doubt the MacroTourist Letter is on the legendary hedge fund manager’s daily reading list, if he happens across this post, Julian (and the rest of you on the board) – know it was all done with tongue firmly in cheek (kind of).

Ryan’s movie DeadPool is by far and away, the best Marvel movie ever made. I guess you can disagree with that statement – that’s what makes a market, but you would still be wrong.

For those who haven’t seen the movie, Ryan Reynold’s character frequents a bar that has a DeadPool. There, listed for everyone to see, are the bets on who will die first. Whoever “owns” the first person to die, wins the pool.

Today’s market is in desperate need of a “Value Investor’s DeadPool.” With the constant fleeing of capital from active management into passive (most of which can certainly not be described as moving into “value”), the pain for those investors still believing that buying cheap companies has merit is intense.

And as I watch this passive investing renaissance unfold, all I can think about is the last time value was so scorned. It was the year 2000, and the DotCom bubble was in full force.

The S&P value versus growth index ratio had been plummeting for four years, and investors were openly mocking those who didn’t “get it” and embrace the new technology era.

Into this mania, one of the greatest value investors of all time, Julian Robertson decided enough was enough, and he closed his Tiger Hedge Fund awfully close to the bottom.

For kicks, I dug up his final letter to investors. The funny part? It seems just as applicable today as 17-years ago.

Tiger Management released the following letter on March 30, 2000 to its limited partners, announcing the closure of its funds.

In May of 1980, Thorpe McKenzie and I started the Tiger funds with total capital of $8.8 million. Eighteen years later, the $8.8 million had grown to $21 billion, an increase of over 259,000 percent . Our compound rate of return to partners during this period after all fees was 31.7 percent . No one had a better record.


Since August of 1998, the Tiger funds have stumbled badly and Tiger investors have voted strongly with their pocketbooks, understandably so. During that period, Tiger investors withdrew some $7.7 billion of funds. The result of the demise of value investing and investor withdrawals has been financial erosion, stressful to us all. And there is no real indication that a quick end is in sight.


And what do I mean by, “there is no quick end in sight?” What is “end” the end of? “End” is the end of the bear market in value stocks. It is the recognition that equities with cash-on-cash returns of 15 to 25 percent , regardless of their short-term market performance, are great investments. “End” in this case means a beginning by investors overall to put aside momentum and potential short-term gain in highly speculative stocks to take the more assured, yet still historically high returns available in out-of-favor equities.


There is a lot of talk now about the New Economy (meaning Internet, technology and telecom). Certainly the Internet is changing the world and the advances from biotechnology will be equally amazing. Technology and telecommunications bring us opportunities none of us have dreamed of.


“Avoid the Old Economy and invest in the New and forget about price,” proclaim the pundits. And in truth, that has been the way to invest over the last eighteen months.


As you have heard me say on many occasions, the key to Tiger’s success over the years has been a steady commitment to buying the best stocks and shorting the worst. In a rational environment, this strategy functions well. But in an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum, such logic, as we have learned, does not count for much.


The current technology, Internet and telecom craze, fueled by the performance desires of investors, money managers and even financial buyers, is unwittingly creating a Ponzi pyramid destined for collapse. The tragedy is, however, that the only way to generate short-term performance in the current environment is to buy these stocks. That makes the process self-perpetuating until the pyramid eventually collapses under its own excess.


I have great faith though that, “this, too, will pass.” We have seen manic periods like this before and I remain confident that despite the current disfavor in which it is held, value investing remains the best course. There is just too much reward in certain mundane, Old Economy stocks to ignore. This is not the first time that value stocks have taken a licking. Many of the great value investors produced terrible returns from 1970 to 1975 and from 1980 to 1981 but then they came back in spades.


The difficulty is predicting when this change will occur and in this regard I have no advantage. What I do know is that there is no point in subjecting our investors to risk in a market which I frankly do not understand. Consequently, after thorough consideration, I have decided to return all capital to our investors, effectively bringing down the curtain on the Tiger funds. We have already largely liquefied the portfolio and plan to return assets as outlined in the attached plan.


No one wishes more than I that I had taken this course earlier. Regardless, it has been an enjoyable and rewarding 20 years. The triumphs have by no means been totally diminished by the recent setbacks. Since inception, an investment in Tiger has grown 85-fold net of fees; more than three time the average of the S&P 500 and five-and-a-half times that of the Morgan Stanley Capital International World Index. The best part by far has been the opportunity to work closely with a unique cadre of co-workers and investors.


For every minute of it, the good times and the bad, the victories and the defeats, I speak for myself and a multitude of Tiger’s past and present who thank you from the bottom of our hearts.

Although this cycle’s decline in value stocks relative to growth stocks has not been as steep as the DotCom bubble, the last ten years has been every bit as painful for the Julian-Roberston-disciples who practice the ancient witchcraft of value investing.

And when I saw one of my favourite investors write a letter to his clients about this very subject, I couldn’t help but draw parallels to the 2000 Tiger closing.

David Einhorn’s Greenlight Capital monthly piece has the same tone as Roberston’s 2000 letter:

I don’t have much to add. As Roberston and Einhorn both say – it will end when it ends (I am paraphrasing).

I am not sure who will be the big name that taps out at the bottom. Probably someone who has made enough money that he/she doesn’t need to bother with this Central Bank fueled madness.

But for long-term investors, think about doing a little style switch down here. You don’t need to fight the market and get short (like your idiot author), but there is nothing wrong with switching some of your higher octane growth names for cheaper value plays. Maybe even give Einhorn a little money – after all, I don’t have Greenlight in the DeadPool. I need him to stick around.


“I’m Out Of The Game” – Traders Abandon China As ‘National Team’ Kills Equity Market

While all eyes have been focused on the collapse in US equity market volatility and its unending upward ramp in the face of 'event risk' large and small, the complacency has crossed the Pacific and crushed China's stock markets to a shadow of their former selves.

While we noted yesterday the seasonal tendency towards lower volatility around this time of year…

As The Wall Street Journal reports, the past 30 trading days, coinciding in part with the 19th National Congress of the Communist Party, have been the least volatile of any 30-day period since the Shanghai exchange reopened in the early 1990s, according to an analysis of FactSet data.

Many investors and traders say Beijing has taken on a more muscular role in markets, following a spectacular market boom and bust in 2015. Securities regulators have called many brokerages and funds over the past year, urging them to say publicly they were bullish about stocks and to refrain from selling shares, market participants say. Some traders cite the price-supporting effect of the “national team” of state investment funds, which they say steps in to buy shares when prices fall.

Since 2015, traders say Beijing has also used the “national team” – large state-backed companies including China Securities Finance Corp. and Central Huijin Asset Management – to help steady markets by buying shares when the market falls sharply and selling when it rises.

These state funds’ shareholdings hit a record high of 4.12 trillion yuan ($622 billion) in June, according to the most recent research by Sinolink Securities , or 7.2% of the total market cap of listed Chinese shares.

The developments have left China’s armies of retail investors – nicknamed “jiu cai,” after the leaves of Chinese chives that quickly regenerate – increasingly disillusioned.

While lower volatility can serve the government’s goal of projecting an image of stability, it can sharply reduce the opportunities for quick profits that many traders depend on.

Which has collapsed China's equity trading volumes…

As The Wall Street Journal continues…

“I’m out of the game,” said Gu Yuan, 34, an information-technology worker in Shanghai who sold almost 70% of a portfolio worth 600,000 yuan ($87,336) after the 2015 market slump and pared down some more this year. “It is more difficult to identify strong tech companies or convincing investment themes since the crash.”

This year’s subdued volatility doesn’t mean China’s markets have truly modernized,  said Michael Pettis, a finance professor at Peking University. He said that the quality of financial information still needs to improve.

“Real value investing requires corporate transparency, high quality of data and predictable government behavior,” said Mr. Pettis. “In China, none of these is easily available yet.”

The country still has 128 million individual investors, according to China Securities Depository and Clearing Corp, a clearing house. Individual investors directly owning stocks fell to 42% in February, the most recent available data, from 55% at the height of China’s bull market in 2015.


A $1.5 Trillion “Quantamental” Market Opportunity

While the debate rages if retail investors have eased on their boycott of the stock market, making it increasingly difficult for institutional investors to dump their holdings of risk assets to Joe and Jane Sixpack even as active investors continue to suffer unprecedented redemptions amid a historic shift from active to low-cost, factor-driven passive management, in today’s Sunday Start note from Morgan Stanley Andrew Sheets, the cross-asset strategist points out that the next $1.5 trillion market opportunity may be a fusion of retail and institutional preferences, namely a low-cost quant approach to investing, coupled with a legacy, fundamental strategy.

As Sheets writes, “$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a  ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth.”

And while that may come as soothing words to asset managers scrambling to shift from fundamental to a fusion, or “quantamental” investing approach, Morgan Stanley then sets a cautious tone asking whether “this growth is occurring at the wrong time” pointing out that “there are serious concerns over whether the flow we’ve already seen into these strategies explains a recent deterioration in performance, and is leading to a dangerous ‘crowding’ of too much money chasing the same factors.”

This goes to the whole “ETFs are socialist products which are destroying both portfolio selection and capitalism, and making markets illiquid, fragmented and at risk of seizure” argument that has been discussed here over the past few years.

For the record, Morgan Stanley is not too concerned, and instead casts the blame on the “unusual environment of distortive central bank policy, an EM and commodity bear market, and high asset correlation. Those dynamics, we think, offer a better explanation for why performance was poor, and incidentally, are all in the process of rolling back.”

What about crowding? According to Morgan Stanley, “this debate is hotly contested, especially as we’ve marked the 10-year anniversary of the ‘quant crash’ in mid-2007. It is difficult to resolve, especially because things don’t need to be popular to have problems, and well-liked strategies can persist for extended periods of time. So we’ll shift the question: Are factors much more expensive than normal (relative to the market), perhaps because of these flows?

For the answer, read the full note from Andrew Sheets below:

Quant and Fundamental – Better Together



We expect significant further growth in assets that are managed with some form of quantitative mandate. That has implications for markets, and for investors trying to navigate them. Later today, we’ll be publishing a detailed analysis of these issues, with a focus on what we see as the most notable opportunity – increasing fusion between fundamental and quantitative approaches. Consider this a preview.


My colleague Michael Cyprys estimates that ~US$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a  ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth.


This ~US$1.5 trillion estimate casts a wide net, from funds that explicitly emphasise a factor like ‘value’ to those doing sophisticated, systematic multi-asset trading. Yet despite this range of complexity, the underlying premise of a rule-based approach is generally the same. Our work focuses on a key building block, factors, which can be thought of as the answer to questions such as “what if every month I just bought cheap stocks and sold rich ones, or bought high-carry and sold low-carry FX, and did that over and over and over again?”


The answer is interesting. There is a litany of work showing the existence of risk premium for these factor strategies over time. We aim to add to this debate by looking at factors from the micro (stock) to macro (asset class) level, globally. Combining the work of Brian Hayes on equity-level factors with work by my colleague Phanikiran Naraparaju on macro ones, we see an encouraging case for diversification, given the (low) correlation of factors to the market and with each other.


But is this growth occurring at the wrong time? There are serious concerns over whether the flow we’ve already seen into these strategies explains a recent deterioration in performance, and is leading to a dangerous ‘crowding’ of too much money chasing the same factors.


Let’s start with recent performance. Over the last five years, systematically trying to own things with better value, carry or momentum has done worse than the long-term average. This is true whether you’re looking at the micro world of stocks or the macro world of asset classes. But we’re not sure that investor flows explain this. First, we’d venture that ‘too much money’ chasing strategies would have the opposite effect, causing these strategies to over-earn.


Second, this period covers an unusual environment of distortive central bank policy, an EM and commodity bear market, and high asset correlation. Those dynamics, we think, offer a better explanation for why performance was poor, and incidentally, are all in the process of rolling back.


Which brings us to crowding. This debate is hotly contested, especially as we’ve marked the 10-year anniversary of the ‘quant crash’ in mid-2007. It is difficult to resolve, especially because things don’t need to be popular to have problems, and well-liked strategies can persist for extended periods of time. So we’ll shift the question: Are factors much more expensive than normal (relative to the market), perhaps because of these flows?


Our work suggests the answer is often ‘no’, with valuations on a majority of factors at both the stock and asset class level closer to long-term averages than extremes. This doesn’t mean there isn’t a risk of drawdowns from automated strategies, but we do think it mitigates this risk, as expensive factors would have further to fall.


However, these risks bring us to our main point – the opportunity in combining quantitative and fundamental approaches. We think that quantitative approaches can benefit from passing through a level of fundamental scrutiny, and fundamental investment analysis can benefit from being aware of where factor exposure exists.


These aren’t, we’d argue, just general platitudes. At the micro level, work by our equity quantitative strategists has shown that stocks favoured by quantitative screens and Morgan Stanley analysts do better than either alone. At the macro level, our new systematic framework for scoring cross-asset factor exposure (CAST) suggests that even simple, unoptimised approaches of screening assets can improve macro calls. For all their promise and sophistication, systematic strategies in financial markets can still struggle with limited data and the difficulty of adapting to regime shifts. Amazon, for example, has scored poorly for years on ‘value’ and ‘carry’. It has still done quite well.


At the same time, if factors do tend to produce positive returns over the long run, why wouldn’t fundamental analysts want to know about them? At the very least, we like the idea of knowing which of our calls are aligned (or misaligned) with value, carry and momentum. And as we search for new views, we look for which assets might have all those properties that we’ve inadvertently missed. At present, assets that our strategists like fundamentally, and also screen well on a factor basis, include Chinese equities and RUB, whereas CHF and JPY screen poorly and are disliked by our strategists.

The implications of the above, if taken to their logical extreme, are concerning: what Morgan Stanley is saying is that contrary to centuries of conventional financial wisdom and study, fundamental, value investing is no longer a key driver of future returns, and instead the things that do matter in this “market”, include what the consensus algo, or robotic trade du jour is, and what quant factor will define returns over the immediate future period.

In other words, the math PhDs have officially taken over. It also means that for the sake of all those legacy traders and investors who learned finance the “old-fashioned way”, they better have practical skills that are applicable far away from what was once Wall Street, and is now just a bunch of algos frontrunning each other and the Fed.


Buffett, Boomers, & The End Of A Bygone Era

Authored by Paul Brodsky via Macro-Allocation.com,

Golden Age

Once upon a time the capital markets consisted of a fairly closed community, comprised on one side by mostly clever, well-connected men working together in syndicate to maintain control over national economic and financial affairs, and on the other side by mostly high earners spread disparately across the land hobnobbing with the syndicate’s local representatives.

It was a privileged ecosystem sanctioned by legally-greased law makers and reluctantly accepted by the great unwashed that acquiesced because capitalism was better than recently defeated fascism and postWar communism, and because, with hard work and production, they too could join the club.

A sequential series of naturally-occurring events successfully transformed and democratized the formerly clubby ecosystem, but in doing so embedded CAT 5 risks into the global productive economy. Consider…

  • Over-spending by US lawmakers in the 1960s led to the end of the global fixed exchange rate monetary system in the 1970s. US dollars and global assets could begin to be leveraged without limit. Global exporters of oil demanded more money in exchange for their finite resource.
  • In the early 1980s, the value of dollars (i.e., US interest rates) was raised to levels that created demand to hold them again, which in turn allowed global trade could resume.
  • Wall Street outsider, Drexel Burnham, using unregulated credit as tool to challenge the control of businesses and asset prices formerly determined unilaterally by the closed ecosystem.
  • Self-directed retirement accounts were created in 1986. They were promoted and adopted throughout society and opened the door for widespread interest in stocks and bonds.
  • The advent and broad adoption of digital technology in the 1980s and 1990s allowed limitless trade processing and easy record keeping.
  • Asset prices rose over time because debt could be easily refinanced at ever lower rates.
  • Law makers were consistently corrupted by their access to unlimited spending, brought about by the debt-generated appearance of broad prosperity through asset growth and political support from beneficiaries nearest to the credit distribution system.
  • Market regulators and economic policy makers were consistently corrupted by law makers exerting pressure on them not to upset the debt-fueled broad economy.
  • Economies successfully migrated from emphasizing private sector production and saving to emphasizing public/private financial management of equity and debt assets that cross collateralized government and household balance sheets.         

Economies became accounting schemes with mutable identities, which is where they stand today. Most Baby Boomers are blithely unaware or unconcerned about the gutting of production-based wealth creation and the unsustainability of the financially-based global economy they built. Gen Xers have trapped themselves between the unstoppable force of deflationary digitization they are building and the immovable object of The Boomers’ Rube Goldberg inflation machine.

Meanwhile, most Millennials care nothing of what was and could be, or of the structural changes they will be expected to endure. (Hey, Gen Xers and Millennials, stop voting for 70 year-olds! Find a 35 year-old to help reconstruct your future.)

A Soon-to-be Bygone Era

Check out the mystery graph immediately below.

Whatever it represents, we have been trained to think its hockey stick pattern must represent irrationality in some way, shape or form, right?

As we said…

We are fans of Mr. Buffett, admire his talent, and wish him a long, prosperous life, but we could think of no better way than his unquestioned success as a financial asset investor to get readers to begin thinking about what they accept as stable and what they accept as bubbles.

While the fact remains that Mr. Buffet has increased his net worth consistently throughout his long life (consistency the graph cannot show because his net worth at fourteen was too small relative to the last few figures), the parabolic rise of his net worth later in life poignantly symbolizes the timing of the underlying shift from production to finance. As he insists in his folksy, humble way, he happens to be the very rare exception in the universe of investors, and if it were not him it would be someone else.

As usual, he is right but oversimplifying things. We can do that too. His investment style, that began as Graham value and drifted into a hybrid that included macro and distressed, always had one unifying constant: inflation. Berkshire and its holdings include insurance and consumer brands with unrivaled moats. All or most of his businesses have had pricing power, which is to say insurance premiums paid today will likely always be higher than claims tomorrow in future dollars, and Coca Cola will likely always keep its profit margins whether a can sells for a nickel or $5. Further, the structure of Mr. Buffet’s investment portfolio means he has been able to defer most of his taxes in perpetuity. 

Mr. Buffet was born in 1930 and so he was positioned to make hay when the golden age of credit and asset inflation arrived.
He has been a professional investor for sixty years. He increased his net worth by about 10,000 times in his first 30 years, from 1956 to 1986 (v. the S&P 500, up about 5 times), and by about 55 times in his second thirty years, from 1986 to now (v. S&P 500, up about 12 times). Don’t let his folksy humility fool you; his talent allowed him to get rich quick many times over six decades.

We have two main observations:

1) Warren Buffet is that very rare individual who was already well-staked, able to quickly identify the shift from production to finance, and then willing to optimize his investment strategy to suit it, and;


2) he would have performed even better with his original brand of value investing had the US policy makers not encouraged every Tom, Dick and Mary to use the public markets as piggy banks. 

Mr. Buffet’s experience in public asset markets is not repeatable.

Already high valuations, investor participation and economic leverage levels ensure that public markets will provide the mass of investors, and even one that may come along as talented as he, with the inability to produce significant real alpha. It was fitting that the Oracle himself predicted last week that the Dow Jones Industrial Average would hit 1,000,000 in the next hundred years. That implies only a 3.87% compounded annual return before inflation. Who are we to argue with the golden boy in his golden years?  


Weekend Reading: Yellen Takes Away The Punchbowl

Authored by Lance Roberts via RealInvestmentAdvice.com,

September 20th, 2017 will likely be a day that goes down in market history.

It will either be remembered as one of the greatest achievements in the history of monetary policy experiments, or the beginning of the next bear market or worse.

Given the Fed’s inability to spark either inflation or economic growth, as witnessed by their dismal forecasting record shown below, I would lean towards the latter.

The media is very interesting. Despite the fact there is clear evidence that unbridled Central Bank interventions supported the market on the way up, there is now a consensus that believes the “unwinding” will have “no effect” on the market.

This would seem to be naive given that, as shown below, the biggest injections of liquidity from the Fed have come near market bottoms. Without the proverbial “punch bowl,” where does the “support” come from to stem declines?

I tend to agree with BofA who recently warned” the paint may be drying but the wall is about to crumble.”

This point can be summarized simply as follows: there is $1 trillion in excess TSY supply coming down the line, and either yields will have to jump for the net issuance to be absorbed, or equities will have to plunge 30% for the incremental demand to appear.”

“An unwind of the Fed’s balance sheet also increases UST supply to the public. Ultimately, the Treasury needs to borrow from the public to pay back principal to the Fed resulting in an increase in marketable issuance. We estimate the Treasury’s borrowing needs will increase roughly by $1tn over the next five years due to the Fed roll offs. However, not all increases in UST supply are made equal. This will be the first time UST supply is projected to increase when EM reserve growth likely remains benign.


Our analysis suggests this would necessitate a significant rise in yields or a notable correction in equity markets to trigger the two largest remaining sources (pensions or mutual funds) to step up to meet the demand shortfall. Again, this is a slower moving trigger that tightens financial conditions either by necessitating higher yields or lower equities.”

Of course, as I have discussed previously, a surge in interest rates would lead to a massive recession in the economy. Therefore, while it is possible you could experience a short-term pop in rates, the end result will be a substantial decline in equities as money flees to the safety of bonds driving rates toward zero.

“From many perspectives, the real risk of the heavy equity exposure in portfolios is outweighed by the potential for further reward. The realization of ‘risk,’ when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. This is why I continue to acquire bonds on rallies in the markets, which suppresses bond prices, to increase portfolio income and hedge against a future market dislocation.”

My best guess is the Fed has made a critical error. But just as a “turnover” early in the first-quarter of the game may not seem to be an issue, it can very well wind up being the single defining moment when the game was already lost. 

In the meantime, here is what I am reading this weekend.



Research / Interesting Reads

“If you are playing the rigged game of investing, the house always wins.” ? Robert Rolih


What The Buffett Indicator Is Really Predicting

Authored by Lance Roberts via RealInvestmentAdvice.com,

Every so often an article is produced that is so misleading that it must be addressed. The latest is from Sol Palha via the Huffington Post entitled: “Buffett Indicator Is Predicting A Stock Market Crash: Pure Nonsense.”  Sol jumps right in with both feet stating:

“Insanity equates to doing the same thing over and over again and hoping for a new outcome. These predictions have been off the mark for almost 10 years. One would think that would be enough for the experts to re-examine the situation, but instead, they use the same lines they used 10 years ago. One day they will get it right, as even a broken clock is correct twice a day.”

Sol should be careful of throwing stones at glass houses. While we are indeed currently in a very bullish trend of the market, there are two halves of every market cycle. 

“In the end, it does not matter IF you are ‘bullish’ or ‘bearish.’ The reality is that both ‘bulls’ and ‘bears’ are owned by the ‘broken clock’ syndrome during the full-market cycle. However, what is grossly important in achieving long-term investment success is not necessarily being ‘right’ during the first half of the cycle, but by not being ‘wrong’ during the second half.”

Will valuations currently pushing the 3rd highest level in history, it is only a function of time before the second-half of the full-market cycle ensues.

That is not a prediction of a crash.

It is just a fact.

The Buffett Indicator

It is also the issue of valuation that leads Sol astray in his article which focuses on one of Warren Buffett’s favorite measures of valuation: Market Capitalization to Gross Domestic Product. 

Sol err’s in the following statement:

Some Experts point out that Warren Buffet is betting on a Stock Market Crash. This claim is based on the fact that Buffett is sitting on $86 billion in cash. They use this information to create the illusion that this Buffett Indicator is predicting a stock market crash.”

First, valuations DO NOT predict market crashes.

Valuations are predictive of future returns on investments from current levels.


I recently quoted Cliff Asness on this issue in particular:

“Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.


If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations.”

We can prove that by looking at forward 10-year total returns versus various levels of PE ratios historically.

Asness continues:

“It [Shiller’s CAPE] has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view, the critics have not provided a good reason this time around — I think you are making a mistake.”

And since we are discussing Mr. Buffett, let me remind Sol of one of Warren’s more insightful quotes:

“Price is what you pay, value is what you get.” 

Importantly, however, let’s take a look specifically at the “Buffett Indicator.”

Not surprisingly, like every other measure of valuation, forward return expectations are substantially lower over the next 10-years as opposed to the past 10-years.

The $86 Billion Question

Of course, while Sol didn’t make the connection between Buffett’s $86-billion in cash and forward-return estimates, he did get Buffett’s reasoning correct.

“Just because Warren Buffett is sitting on billions of cash does not mean he is waiting for the market to crash. He is probably waiting for a good deal; that’s all.

Some might point out that it’s the biggest hoard of cash the company has ever built up and that this indicates Buffett is nervous. Being nervous does not equate to betting on a stock market crash. Buffett is a value player and he is looking for a deal, so correction not crash might be all he is waiting for.

Unfortunately, “good deals” based on valuation levels and market crashes have typically been highly correlated.

But more importantly, Sol also misses an important point made by Buffett in terms of value investing:

“Buffett Does not believe stocks are overpriced; hence he is not expecting a stock market crash.”

However, he goes on to quote Buffett suggesting the possibility.

“While Buffett agrees the market can go through period of turbulence, he stated that ‘no one can tell you when these traumas occur.'”

And then states these “traumas” could range from mild to “extreme.”

Sounds like a crash to me.

But then he makes the most interesting point.

In a recent article, Buffett stated that stocks were on the cheap side; one does not make a comment like this if one believes the stock market is going to crash.”

That point doesn’t quite square with Buffett holding his largest cash pile in the history of the firm.

Buffett is a businessman that runs an investment company. Yelling “fire in a crowded theater” would likely not be well accepted well by his investors and legions of avid followers.

In the business, this is called “talking your book.”

However, what a portfolio manager says (“stocks are cheap”) and what they do ($86 billion in cash) are two very different things.

As the old saying goes: “Follow the money.” 

Fundamentals Don’t Matter

I will agree with Sol on his point that fundamentals don’t matter at the moment.

In a market that where momentum is driving an ever smaller group of participants, fundamentals are displaced by emotional biases. Such is the nature of market cycles and one of the primary ingredients necessary to create the proper environment for an eventual crash.

Notice, I said eventually.

I do agree with Sol that markets are indeed currently bullish and therefore, as an investment manager, portfolios should remain tilted towards equities currently.

But such will not always be the case.

As David Einhorn once stated:

The bulls explain that traditional valuation metrics no longer apply to certain stocks. The longs are confident that everyone else who holds these stocks understands the dynamic and won’t sell either. With holders reluctant to sell, the stocks can only go up – seemingly to infinity and beyond. We have seen this before.


There was no catalyst that we know of that burst the dot-com bubble in March 2000, and we don’t have a particular catalyst in mind here. That said, the top will be the top, and it’s hard to predict when it will happen.”

Is this time different?

Probably not.

James Montier summed it up perfectly in “Six Impossible Things Before Breakfast,” 

Current arguments as to why this time is different are cloaked in the economics of secular stagnation and standard finance workhorses like the equity risk premium model. Whilst these may lend a veneer of respectability to those dangerous words, taking arguments at face value without considering the evidence seems to me, at least, to be a common link with previous bubbles.

While investors insist the markets are currently NOT in a bubble, it would be wise to remember the same belief was held in 1999 and 2007. Throughout history, financial bubbles have only been recognized in hindsight when their existence becomes “apparently obvious” to everyone. Of course, by that point, it was far too late to be of any use to investors and the subsequent destruction of invested capital.

This time will not be different. Only the catalyst, magnitude, and duration will be.

Investors would do well to remember the words of the then-chairman of the Securities and Exchange Commission Arthur Levitt in a 1998 speech entitled “The Numbers Game:”

“While the temptations are great, and the pressures strong, illusions in numbers are only that—ephemeral, and ultimately self-destructive.”


Mauldin: “4 Charts Why You Should Run Away From The S&P 500”

Authored by John Mauldin via MauldinEconomics.com,

My friend James Montier, now at GMO, and his associate Matt Kadnar have written a compelling piece on why passive investors should avoid the S&P 500.

Their essay argues that the forward growth potential of the S&P 500 is significantly lower than that of other opportunities, especially emerging markets.

Let’s look at a few of their charts.

For the Next 7 Years, S&P 500 Returns Will be a Negative 3.9%

The chart above breaks the total return from the beginning of the current bull market in the S&P 500 into its four main components: increasing multiples, margin expansion, growth, and dividends.

He notes that this total return is more than double the level of long-term real return growth since 1970.

If earnings and dividends are remarkably stable (and they are), to believe that the S&P will continue delivering the wonderful returns we have experienced over the last seven years is to believe that P/Es and margins will continue to expand just as they have over the last seven years. The historical record for this assumption is quite thin, to put it kindly. It is remarkably easy to assume that the recent past should continue indefinitely, but it is an extremely dangerous assumption when it comes to asset markets. Particularly expensive ones, as the S&P 500 appears to be.

More bluntly put, the historical record supporting this assumption is non-existent. It never happened. Just saying…

The authors then describe how they build their seven-year forecasts of S&P 500 returns.

They argue that for the next seven years, returns will be a negative 3.9%. Note that GMO is not a perma-bear money-management business. Their forecasts were extremely bullish in February 2009.

They are a valuation shop, pure and simple. Investors—typically large institutions and pension funds—that are leaving Grantham’s management firm now are going to regret it. The consultants or managers who suggested that move are going to need to polish their résumés.

No Good Options Are Left

The bottom line? “The cruel reality of today’s investment opportunity set is that we believe there are no good choices from an absolute viewpoint – that is, everything is expensive (see the chart below).”

For a relative investor (following the edicts of value investing), we believe the choice is clear: Own as much international and emerging market equity as you can and as little US equity as you can. If you must own US equities, we believe Quality is very attractive relative to the market. While Quality has done well versus the US market, long international and emerging versus the US has been a painful position for the last few years, but it couldn’t be any other way. Valuation attractiveness is generally created by underperformance (in absolute and/or relative terms). As Keynes long ago noted, a valuation-driven investor is likely seen as “eccentric, unconventional, and rash in the eyes of average opinion.” [Emphasis mine.]

In absolute terms, the opportunity set is extremely challenging. However, when assets are priced for perfection as they currently are, it takes very little disappointment to lead to significant shifts in the pricing of assets. Hence, our advice (and positioning) is to hold significant amounts of dry powder, recalling the immortal advice of Winnie-the-Pooh, “Never underestimate the value of doing nothing” or, if you prefer, remember—when there is nothing to do, do nothing.

Markets appear to be governed by complacency at the current juncture. Indeed, looking at the options market, it is possible to imply the expected probability of a significant decline in asset prices. According to the Minneapolis Federal Reserve, the probability of a 25% or greater decline in US equity prices occurring over the next 12 months implied in the options market is only around 10% (see Exhibit 12). Now, we have no idea what the true likelihood of such an event is, but when faced with the third most expensive US market in history, we would suggest that 10% seems very low.

Those are wise words indeed.


Weekend Reading: Losing Faith?

Authored by Lance Roberts via RealInvestmentAdvice.com,

Last week, I penned the following:

“Now, you would suspect the possibility of nuclear war might just be the catalyst to send markets reeling, but looking at the market’s reaction on Thursday, I suspect there will be t-shirts soon reading:


‘I survived the threat of nuclear war and the ‘great crash of 2017’ of 1.5%'”

Of course, as markets touched on their 50-dma, the algos kicked in hard on Monday morning sending the markets surging higher. The reason, according to the media, was the reduction in global risk as Donald Trump briefed Kim Jung-Un about the U.S.’s retaliatory response should North Korea decide to attack Guam.

I was able to acquire a copy:

And with that…. “NOMO NOKO” as Kim Jung-Un backed off his more aggressive posture, letting traders rush back into the markets to once again “BTFD.”

That excitement was short-lived.

On Wednesday, following a conflicted response by the White House to the Charlottesville, VA. protest, numerous CEO’s resigned from Trump’s economic council. The resignations eventually led to its full dismemberment.

Surprisingly, and as we have addressed in recent weeks, this was the catalyst that sparked a sharp decline on Thursday? Have investors “Lost The Faith?”

With President Trump embroiled in one entanglement after another and constrained by a deeply partisan legislature, the ability of the Administration to pass legislative agenda seems to be fading. 

The reality is this was the headline. Over the last couple of months, the markets have remained on a weekly “sell signal,” at a very high level, even as stock prices continued to struggle higher amid eroding internal measures. However, the break below the “accelerated advance trend line,” as noted, suggests the current correction could accelerate IF the markets don’t regain their footing by Monday.

One note of importance is that outside of the speculative enthusiasm of investors, there has been a continuing pressure in earnings as the lack of legislative agenda advancement is beginning to weigh on Q3 estimates.

Given the bulk of the upward push in earnings estimates since the election was based on hopes of tax reform/cuts and infrastructure spending, the realization such will not occur soon is elevating the “risk of disappointment.”  Without a driver to push economic growth higher, the market has likely priced in the majority of expectations.

The repricing of expectations could be fairly brutal. 

Just remember, the “running of the bulls” was the method to transport the bulls from the fields to the bull ring where they were killed later that evening.

As with the market, it’s great to be the “bull” until you get to the end of your run. 

Here’s what I am reading this weekend.


Thoughts On Long-Term Investing


Research / Interesting Reads

“While some might mistakenly consider value investing a mechanical tool for identifying bargains, it is actually a comprehensive investment philosophy that emphasizes the need to perform in-depth fundamental analysis, pursue long-term investment results, limit risk, and resist crowd psychology.” – Seth Klarman