The Reformed Broker
An elementary student walks past a screen displaying the Korea Composite Stock Price Index (KOSPI) during an educational visit to learn about stock market systems at the Korea Exchange's information centre in Seoul in this 2011 file photo. Vaue managers are struggling to stay ahead of volatile global markets. (Jo Yong-Hak/Reuters/FIle)
How are value managers predicting global markets?
The economy is slowing and the stock market is expensive.
There, now you know what the data says, empirically speaking. Now let's talk anecdotally...
I was visited last week by one of the largest global value managers in the world (AUM $50 billion plus) last Friday. Their flagship fund, the one I use in that slot for client accounts, is running about 18% cash right now, 9% Japanese equities and only 36% US stocks. They rarely hold cash as cash, usually they'll buy the short-term commercial paper of the companies they like on the equity side - this allows them to pick up some extra points when they're highly liquid.
I ask them why the almost 20% cash position, is there something they're seeing in the macro data or the headlines that their peers (who are much more heavily long) don't necessarily see?
No, they tell me, they don't play that game in terms of trying to read the macro tea leaves or anticipate the political outcomes in the 17-nation Euro Zone. Rather, they've got a 20% cash pile because as they've sold things, they've not been able to find replacement candidates worth buying given their bottom-up approach. It's a combination of stocks not being cheap enough around the world to offer the "margin of safety" they live by and earnings growth being non-existent across much of the global landscape.
One pocket of interesting buys is in European multi-nationals that do most of their business outside Europe. These stocks are being pressured because of the Euro exchanges they are listed on despite the fact that they don't have the perceived exposure to Euro economies that people assume. The Japan overweight is derived from a similar viewpoint - large corporations in Japan that are selling outside of Japan. There are some buys in areas like forestry and cement as well in these regions.
Ordinarily the fund would be looking at the European bank equities, but there's that nagging margin of safety dearth again - how can you calculate the value of a business when everything on a balance sheet is being masked from shareholders? So while Euro bank stocks may appear "cheap" on the surface, they fail the litmus test that's gotten this fund through some rough times over the last 30 years.
Worth noting here is the fact that this fund was also peaking out in cash as a percentage of assets in 2007. Again, it wasn't that they were studying the macro concerns and coming to the right conclusions then either - their cash hoard was a function of not being able to find value with good fundamentals and a margin of safety. Stocks were expensive and underlying fundamentals were beginning to turn the wrong way, so they sat back and bought nothing.
They are in much the same position today.
The economy is slowing and the stock market is expensive.
There, now you know what the data says, empirically speaking. Now let's talk anecdotally...
I was visited last week by one of the largest global value managers in the world (AUM $50 billion plus) last Friday. Their flagship fund, the one I use in that slot for client accounts, is running about 18% cash right now, 9% Japanese equities and only 36% US stocks. They rarely hold cash as cash, usually they'll buy the short-term commercial paper of the companies they like on the equity side - this allows them to pick up some extra points when they're highly liquid.
I ask them why the almost 20% cash position, is there something they're seeing in the macro data or the headlines that their peers (who are much more heavily long) don't necessarily see?
No, they tell me, they don't play that game in terms of trying to read the macro tea leaves or anticipate the political outcomes in the 17-nation Euro Zone. Rather, they've got a 20% cash pile because as they've sold things, they've not been able to find replacement candidates worth buying given their bottom-up approach. It's a combination of stocks not being cheap enough around the world to offer the "margin of safety" they live by and earnings growth being non-existent across much of the global landscape.
One pocket of interesting buys is in European multi-nationals that do most of their business outside Europe. These stocks are being pressured because of the Euro exchanges they are listed on despite the fact that they don't have the perceived exposure to Euro economies that people assume. The Japan overweight is derived from a similar viewpoint - large corporations in Japan that are selling outside of Japan. There are some buys in areas like forestry and cement as well in these regions.
Ordinarily the fund would be looking at the European bank equities, but there's that nagging margin of safety dearth again - how can you calculate the value of a business when everything on a balance sheet is being masked from shareholders? So while Euro bank stocks may appear "cheap" on the surface, they fail the litmus test that's gotten this fund through some rough times over the last 30 years.
Worth noting here is the fact that this fund was also peaking out in cash as a percentage of assets in 2007. Again, it wasn't that they were studying the macro concerns and coming to the right conclusions then either - their cash hoard was a function of not being able to find value with good fundamentals and a margin of safety. Stocks were expensive and underlying fundamentals were beginning to turn the wrong way, so they sat back and bought nothing.
They are in much the same position today.
Republican presidential candidate Mitt Romney and his wife Ann board their charter plane in Tel Aviv, Israel as they travel to Poland, Monday, July 30, 2012. (Charles Dharapak/AP)
Mitt Romney: Could a victory mean a stock market surge?
Sam Ro just published some recent commentary from Morgan Stanley's bearish chief strategist Adam Parker. Parker says that one thing that could change the tone of this market for the better would be a perceived or actual victory of Mitt Romney:
The biggest possibility here would be Romney winning the Presidential election. Our guess is that the market multiple would expand if in fact more investors start believing Romney will win. Secondly, we think an improving outlook in China could create a bid for cyclicals in the US, given how much they have sold off. Interestingly, the microstructure of the market rally this past week was not full-on beta, with health care (our largest overweight) the best performing sector in Friday’s large uptrend. Investors are worried, they are just not worried now. We think the time for more worry is near. Perhaps the champagne should be for mood enhancement, not for celebration.
I agree with him. The research shows that there is no stock market benefit in real life as to which party controls the White House. But in this case, the business community is sick and tired of being sick and tired, they'd welcome the change with a great deal of pent-up optimism about the future. Mitt is running as a fiscal conservative (because he has to) but in general, most of us know that he will keep taxes low and maybe even seek to cut them further to stimulate the economy. The odds of a healthcare roll-back are slim but the potential would certainly stoke the fires as well.
A trader watches his screens on the floor of the New York Stock Exchange, July 27, 2012. Brown argues that the concept of being a "trader" on the stock market is one that needs a but of de-romanticizing (Brendan McDermid/Reuters)
Is prop trading dead?
Is Prop Trading Dead?
Or is it just the fact that most prop trading firms, as they are currently constituted (student pays to be taught, 1 in 20 kids graduates and becomes consistently profitable, traders are regulated by Finra as brokers, etc.), cannot survive without some evolutionary change?
Have the algos finally finished their work, leaving almost no room to breathe for the human daytrader?
I'm not an expert on this particular corner of the market, although I have many, many friends and acquaintances who are involved in some way, shape or form. There are two stories you should read on the topic if you're interested:
Start with:
Letters to a Young Trader (Dynamic Hedge)
and then the response from Mike Bellafiore:
The Opportunity for a Prop Trader (SMB Capital)
The concept of being "a trader" is one that has long been in need of a bit of de-romanticizing. It is not an adventure or a ride alongside charming, debonair riverboat gamblers. The slings and arrows of outrageous fortune one hopes to encounter and best come in the disguise of a blinking cursor and a flickering column of quotations.
Trading is about as romantic as any other exacting profession that relies on repetition and discipline. Meaning not at all, most of the time.
In this June 2012 file photo, Microsoft CEO Steve Ballmer comments on the Windows 8 operating system at Hollywood's Milk Studios in Los Angeles. Microsoft Corp. Tech investors are starting to give up on Microsoft following the disappointment of Windows 8. (Damian Dovarganes/AP)
Is it time to give up on Microsoft?
This is anecdotal, not empirical, but the two smartest value-oriented investors writing blogs just simultaneously threw in the towel on Microsoft ($MSFT). In both cases, the trigger was the new Windows 8 operating system. The techies seemed to have known for awhile that 8 would be a letdown, it is well documented throughout the tech blogosphere. But now that dissatisfaction is making its way through the investing community.
First, my pal Vitaliy Katsenelson, the brilliant investor and author of Contrarian Edge. In his latest article at Institutional Investor, he begins thusly:
I sang love serenades to Microsoft in the December issue, but a few weeks ago we sold our shares of Microsoft. Because we believe the stock is undervalued, that decision was not easy. What changed? A very important part of my thesis was the success of Windows 8, an operating system that Microsoft made for both PCs and tablets. When I saw Windows 8 demonstrated in early 2011, it looked like a very innovative, un-Microsoft-like product. Windows 8 was very important for Microsoft’s response to Apple’s iPad — a tablet that was deservingly stealing market share from low-end laptops. Windows 8 was supposed to take Microsoft to the next level, leapfrogging Apple and Google.
A few months ago Microsoft released the public Windows 8 beta, and I tested it out. To my shock, I found it to be a very confusing product. The interface was slick and visually very appealing, but I simply could not figure out how to use it...
And then last night I saw John Hempton, legendary blogger and hedge fund manager at Bronte Capital, say that he had also sold out of Microsoft because of the new OS:
Seldom have I looked at something that is a major long in the portfolio, changed my mind, sold the entire position and continued selling to go short (albeit in a small way).
I just did that on Microsoft. The immediate trigger was Windows 8 - but the thinking has been longer and harder than that.
There are important points made in both articles, I highly suggest you read them - even if you disagree.
Calpers headquarters is seen in Sacramento, Calif., in this 2009 file photo. Calpers, the largest U.S. public pension fund, manages retirement benefits for more than 1.6 million people. Some analysts say some pension funds are at risk because they have bought up junk bonds to maintain returns at a time of historically low interest rates. (Max Whittaker/Reuters/File)
Junk bonds spawn optimists, pessimists. Are they both right?
The junk bond rally - and the whole investment grade corporate bond rally for that matter - can be looked upon from two opposing viewpoints. The optimists will tell you that it is a sign of underlying strength in the economy, denoting the fact that US creditors are comfortable with the risks involved with lending to these companies. The pessimists will tell you that the creditors will be proven foolish and eventually lighter in the wallets, so who cares what their willingness to lend may signal?
Below I've got a smart take from both an optimist and a pessimist on the junk bond rally and the fact that investors in the high yield market are DTF (Down to Finance):
First, here's Ryan Detrick, Chartered Market Technician (CMT) and Senior Technical Strategist at Schaeffer's Investment Research:
With that said, there are still two areas holding up well that make me think the economy won'ttank, and could very well improve drastically during the second half of the year. Housing and junk bonds are both showing some major improvements, and this is definitely an encouraging sign. The majority of the housing data over the past two months has been very positive. In fact, housing starts in June came in at their highest level in three years. Turning to junk bonds, they can be a very good gauge of economic growth. Think about it -- these are bonds on the riskiest of companies, and improvements here show an appetite for risk. Why would anyone buy bonds if you think the company paying would just default? Right now, various junk bonds are breaking out -- suggesting the economy could be on much better footing than most give it credit for.
A perfectly reasonable, logical and historically accurate line of commentary.
But then there's this bit on how the junk rally is a massively obvious bubble, from Stephanie Pomboy (MacroMavens), who was quoted extensively in this weekend's Barron's:
And Stephanie's nothing if not adamant that the junk portion of the bond market meets "all the standard criteria of a bubble." She cites, by way of illustration, the fact that junk yields are now "hovering around the all-time lows notched in 2005 -- the absolute peak in the greatest asset bubble and credit-financed expansion of our lifetimes.''
Further evidence of the junk-bond bubble if you harbor any doubts on that score is that, according to the EPFR Global, in the first quarter of this year investors put a hefty $33 billion into high-yield bond funds -- four times as much as they bought in all of 2011. In the past three years, assets of junk bond funds have more than doubled.
And when the bubble bursts, as Stephanie believes it inexorably will, among the likely big losers are Jane and John Q. who saw junk as a way to possibly recoup some of their vicious real-estate and stock-market losses, and insurance companies, the biggest holders of corporate debt and the largest counterparties in the derivatives market.
And pension funds are front and center on the endangered list, having, as Stephanie notes, "loaded the boat with junk in a desperate attempt to meet 8%-plus return assumptions in a 1.5% risk-free world."
Please bear in mind that Stephanie's "Hear Me Now, Believe Me Later" newsletter from March of 2006 was one of the most frighteningly prescient pieces of market forecasting ever written. It was the ultimate spoiler alert, written in a runaway bull market no less, about how the housing bubble was going to collapse and destroy the economy on its way down.
No it is very possible, of course, that they are both right (as they would have been at the prior record low-yields for junk from back in 2005). In that example we did, of course, get quite a solid 18 months out of both the stock market and the economy before the eventual collapse began in late 2007. And so in in the case of 2005, both the optimists and pessimists would have been right on the high yield market and it's meaning. Junk bonds rallying was both a sign of strength and a distant early warning about the quality of liquidity splashing about back then.
But what does the junk bond rally mean this time around? Is the dour take from Stephanie correct or is Ryan's citation of healthy financing for junk one more sign that the recovery is still alive and well under the surface?
RELATED: Can you manage your money? A personal finance quiz.
Specialists Charles Boeddinghaus, left, and Douglas Johnson, work at their posts on the floor of the New York Stock Exchange last week. The best portfolio managers avoid action bias – the temptation to do something even though there's no move to make. (Richard Drew/AP/File)
Hedge fund manager: patient and confident enough to do nothing
My post yesterday contrasting Seth Klarman with many of his more well-known hedge fund peers has generated a ton of feedback, which is cool. The one thing I did not do in the post was explain why Klarman was so influential and inspirational for me. So I'll do so here...
I am not a value investor myself although I respect the discipline and we incorporate lots of what value investing emphasizes into our metrics. And so while other value investors may find themselves enamored with Klarman's ability as a stockpicker or an analyst, I find myself way more impressed with the manner in which he runs his practice.
For example, short-term Greatest Trade Ever-type activity is a foreign concept to Baupost. There is no leverage, there is frequently a lot of strategic excess liquidity and there are no qualms about "underperforming" in the short-term in order to outperform in the long. Everyone says they're all about this but I still manage to lose a client or two at virtually every short-term market top, as do many disciplined, sober money managers - there's always some fast-talking asshole or glinting object beckoning investors out into the wild, after all. Good riddance.
But Klarman's got his practice and its clientele figured out. From The Economist piece I linked to yesterday:
Mr Klarman is patient and confident enough to do nothing. He currently has around 30%—and has been known to have as much as 50%—of his portfolio in cash...
Given Baupost's allure, it could easily make a killing on fees. But Mr Klarman eschews the generous “2 and 20” compensation structure typical of most hedge funds...Instead, old investors pay “1 and 20”, and newer ones (he has let them in twice, in the early 2000s and 2008) no more than “1.5% and 20”.
That is not the only way Mr Klarman has positioned Baupost in contrast to other funds. He thinks one of investors' greatest mistakes is chasing short-term performance and obsessively comparing returns with those of competitors and with benchmarks. In the year to April, Baupost was up by around 2%, trailing the S&P 500 (which was up by 11.9%) and the average hedge fund (4.4%). He is probably the only hedge-fund manager ever to tell investors that he does not want to be their best-performing fund in a given year, as he did in a recent letter. He has deliberately maintained a sticky investor base composed almost entirely of endowments, foundations and families, which understand his investment philosophy and will not redeem after a few negative quarters.
This man is a professional in every sense of the word. He knows what he is capable of delivering and what he's not interested in attempting. One of the most difficult concepts that money managers and their clients grapple with each day and week and month is the Action Bias. Sometimes there is no move to make and no reason to even look for one. But managers are afraid to stand still in a portfolio for fear that their clients will chalk that inactivity up to laziness, apathy or fear. This tension exists at almost every asset management shop in the country, believe me.
But not at Baupost. There are no hot money accounts to keep satisfied and Klarman does not build expectations to unreasonable levels.
This is an asset management philosophy and style I aspire to every day.
A reveler falls on Estafeta corner running with Torrehandilla's fighting bulls ranch, during thet running of the bulls at the San Fermin fiestas, in Pamplona northern Spain in this July 2012. As the stock market fluctuated this week, commentator Alan Abelson decries the so-called "bad-news bulls," with their inexplicable compulsion to get in at the top of what looks like a cyclical rally. (Alvaro Barrientos/AP)
Alan Abelson and his 'Bad-news Bulls'
Having read his column for over 15 years, I can tell you definitively that Alan Abelson is at his best when writing on a Friday afternoon during which the market is in its classic summer lethargy give-up mood, which is exactly what transpired at the end of this week. Somewhere between Schadenfreude Street and I-Told-You-So Avenue, Abelson finds his home turf as a market commentator - I go straight to his page on weekends like this one.
Here he ribs the bulls who've been using bad news as their cue to add even more exposure over the past month...
The bad-news bulls are back! Every newly uncovered scandal, every morsel of hideous fraud, every fresh revelation of bank mischief and regulatory lapse that normally would make investors' stomachs churn instead seem to conspire to embolden them to buy equities.
We're talking here about the same investors who it feels like only yesterday were horrified at the notion of sticking so much as a toe in the market, all but paralyzed by the wounds inflicted by the Great Recession and its progenitor, the financial crisis. Suddenly, they've begun to act with an urgency that bespeaks an uncontrollable and a virtually inexplicable compulsion to get in at the top of what for all the world looks like a cyclical rally.
I definitely see some of this activity going on. Abelson explores the obvious negatives in his piece and decries our inability to sell the market off down to levels at which bears will feel satisfied that the negatives are being respected.
The one thing he forgets (or leaves out) is that the world is waking up to the fact that there aren't any other alternatives. That's how you get Intel, IBM and Qualcomm reporting not-so-great earnings and then rallying 5%+ the next day (happened on Thursday). Because in the battle between weak growth and tepid returns versus negative real rates of return (bonds), guess what wins over the intermediate-term...
RELATED: How skewed is America's income inequality? Take the quiz!
In this May 2012 file photo, electronic screens show the price of Facebook shares after they began trading in New York. After the Facebook IPO debacle, tech companies seemed unwilling to face the same possibility. But in a welcomes sign that that attitude may be changing, tech companies Kayak and Palo Alto Networks both have gone public with positive results. (Richard Drew/AP)
Breaking the Facebook curse, two new tech IPOs go public
The Facebook IPO debacle has finally subsided and solid companies in the tech space can once again come public with warm receptions. Palo Alto Networks ($PANW) is up 33% from it's IPO price today as of this writing. The company is in the business of replacing old and outmoded firewalls for large corporate customers so that security is in place for the more collaborative social networks we use today and all the new Web 2.0 applications. Social network security is a big deal becoming a bigger deal everyday, this is a mega-trend. Palo Alto sells their software and hardware products to more than 7700 customers up from just 1800 just two years ago. I haven't done much research on the stock but I like the space and I probably will.
The other IPO is in the web travel space, Kayak ($KYAK). You're probably familiar with the company and it's service, people seem to like it - the ease of use, the interface etc. I personally don't like these consumer web names anymore though, especially ones in hyper-competitive fields like this one is in, so I'm probably just a spectator there.
But putting the companies themselves aside for a moment, it's a nice sign that tech IPOs are back again. Especially at a time like this, what with Spain being beaten to death with its shoes today.
Mark Prather an ERA broker, poses for a portrait in Yorba Linda, Calif. in this June 2012 file photo. Across the country, breakway brokers, realtors and builders, many of whom are small businesses, are seeing a sales comeback. (Nick Ut/AP)
Breakaway brokers find a surprisingly bullish market
The breakaway broker trend is still full steam ahead according to TD's head of RIA biz Tom Nally (full disclosure, TD Ameritrade Institutional is my firm's primary custodian for client accounts.)
From Investment News:
The firm attracted a record 120 breakaway brokers to the RIA model and the custodian platform last quarter. That's almost 50% more than the same period in 2011. For fiscal 2012 — TD's year-end is in September — the company has signed up 324 breakaway brokers, a 23% gain over last year's first three quarters.
“The RIA is now the aspirational model for brokers,” said Mr. Nally, who was previously TD's managing director of institutional sales. “We don't see the trend slowing down. We have more brokers actively engaging us all the time.”
One major driver of the movement is the beating big Wall Street houses took in the financial crisis, according to Mr. Nally. “People are just not as enamored with the old brands as they used to be,” he said.
I myself broke away in 2010 and dropped my series 7 finally last year. The markets are tough but I can't remember ever feeling this good about how I'm able to manage client accounts now.
President Barack Obama speaks at a fundraising event in Austin, Texas on Tuesday, July 17, 2012. Some more optimistic experts hope President Obama and Congress will pledge to build upon the Simpson-Bowles reform plan going forward, despite the upcoming November election. (Jack Plunkett/AP)
On brink of 'financial cliff,' at least one analyst remains hopeful
I read Lloyd Blankfein's op-ed at Politico this morning and I found myself in agreement with a lot of what he said (the piece was about investing in America). One area I disagree with him on is the chance of any kind of fiscal accord taking place without a massive battle. Blankfein thinks it may be possible to avoid, I hope he's right but I don't think so...
From Politico:
Make progress on the long-run fiscal situation: Economic and investment sentiment suffered last year as a result of the congressional standoff over the federal debt limit. In the end, however, that debate produced $900 billion of debt reduction and an additional $1.2 trillion of spending cuts over 10 years, which will be mandated by sequestration if no other action is taken.
Realistically, while few expect a fiscal reform agreement before the November election, we should not discount the value of a declaration by congressional leaders of both parties, as well as President Barack Obama and former Massachusetts Gov. Mitt Romney, that Simpson-Bowles will be the basis of future reform. Simpson-Bowles presented a serious, responsible and bipartisan effort to improve the long-term fiscal outlook. Embracing its broad conclusions will send the right message to investors and corporate managers that we will make progress on our long-run budget challenges — and that now is the right time to commit capital and invest in the U.S.
Guess we shall see.
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