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Commentaries
APRIL COMMENTARY, 2010
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SECOND
QUARTER COMMENTARY, 2009
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FIRST
QUARTER COMMENTARY, 2009
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FOURTH
QUARTER COMMENTARY, 2008
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“Madness is something rare in
individuals -- but in groups, parties, peoples it is
the rule.”
Friedrich Nietzsche
Reports of the end of the world are premature.
…….in the next year or two we’ll see a 12 month
period with a 50% rise in the major stocks average.
THIRD
QUARTER COMMENTARY, 2008
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“Pessimistic visions about
almost anything always strike the public as more
erudite than optimistic ones.”
Joseph Schumpeter
What is going on here is a classic panic. Markets
have simply ignored any underlying fundamentals and
are acting on pure emotion.
….by every measure, valuations are incredibly cheap.
Bear markets tend to end quickly and recover
unexpectedly…
Just because it is on TV, in the newspaper or on the
internet has no bearing on whether it may actually
be true.
SECOND QUARTER COMMENTARY, 2008
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“Bankers have come up with these new ways to lose money when the old ways were
working so well.”
-John Stumpf
An inevitable part of the investment business is forecasting and prognosticating. As part
of managing money, therefore, I spend an inordinate amount of my time reading and
watching the views and predictions of others in order to discern the good from the bad
and the valid from the ridiculous (sort of an intellectual separation of wheat from chaff).
Normally these predictions tend not to vary a great deal as presumably no one wants to
look too silly being separated from the herd if their prediction goes awry. This has
certainly not been the case lately, however as predictions have ranged from “everything
will be just fine” to “Armageddon.” Needless to say the latter tends to get much more
press. This media malaise has led to what one observer termed “an emotional recession.”
So, with that backdrop, let’s take a closer look at the current situation and see if we can’t
sort this out for ourselves.
By my observation we are in the throws of four separate, but interrelated, crises at once;
credit, residential real estate, derivatives and energy. So let’s look at each of these in
order to try to understand the dynamics and interrelations a little better.
FIRST
QUARTER COMMENTARY, 2008
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“There is the dangerous cliché in the financial world that everything depends on
confidence. One could better argue the importance of unremitting suspicion.”
-J. K. Galbraith In last quarter’s commentary I tried to provide some historical backdrop for the current
credit crisis (or panic, if you prefer). This quarter, I’ll follow up and look a little more
closely at the current debt crisis, review how we got here, the current dominant themes
and mind sets as well as some of the possible outcomes. Let me just start by reiterating
the point of last quarter’s commentary, which was we’ve had numerous credit crises over
the last 200 years and they all came to an end and confidence was ultimately restored.
Risk, It’s Baaaack……
FOURTH
QUARTER COMMENTARY, 2007
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“Be of Good Cheer – We Will Be Over It Soon.”
-Andrew Carnegie, referring to the Panic of 1893
Given the volatility of the markets in recent weeks, you are likely
(and hopefully) looking to this commentary for some explanation of it
and some sense of when and how it may end. I’ll try to accomplish both
in the following pages by reviewing and updating the quarter’s
developments as well as providing a historical context within which to
view them. As a preview, it is safe to say that, for better or worse,
there is nothing unprecedented in these recent events when viewed in
the broader context of financial history.
In
last quarter’s commentary the development of the subprime mortgage
situation (variously referred to as a “mess,” “debacle,” or “crisis” in
the press) was explained in great detail with brief references to
similar problems developing in the corporate bond and derivatives
markets. This time we’ll look more closely at these latter two in the
context of the current market and economic situation.
THIRD
QUARTER COMMENTARY, 2007
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“The investor's chief obstacle - indeed, his worst enemy - is likely to be himself.”
-Ben Graham
A Funny Thing Happened on the Way to the Beach
The third quarter started with all of the earmarks of a pleasant summer
of investing. Into July the mergers and acquisition boom looked like it
would never end and the major market indices were hitting new highs.
Then the subprime mortgage crisis hit like a ton of bricks.
The late MIT Professor Rudi Dornbusch sagely observed that in financial
markets things always take longer to happen than you expect, but once
they happen events unfold much more quickly than you expect. This would
seem to perfectly describe the events of the third quarter.
By mid-August the wheels had come off the mergers-and-acquisition
bandwagon and major stock indices were down nearly 10% from their highs
set just a month earlier. What can only be described as sheer panic
gripped the credit markets. Fallout from bad subprime mortgage loans in
the US began to pop up at financial institutions around the world like
a game of Whack-A-Mole, The Global Economic Edition.
SECOND QUARTER COMMENTARY, 2007
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Pride Goeth Before the Fall
-Proverb
When
reviewing topics for this quarter’s commentary, the choice seemed
obvious, Private Equity. Why so obvious you ask? Well, if you haven’t
noticed the topic has dominated seemingly every TV show, newspaper and
magazine recently. At least the ones I watch and read, anyway. Not a
day goes by as of late where the Wall Street Journal doesn’t read like an issue of The Private Equity Review.
On TV we used to at least get some break in the private equity coverage
with the latest Paris Hilton news. That ended last week when it was
announced that Hilton Hotels were being bought out by a Private Equity
firm. No word on whether Paris was part of the transaction.
What Is It? By
now you (hopefully) know that equity is just another word for ownership
of a company. You have also certainly heard the term “going public”
which refers to a company selling shares of its stock to the public. In
other words, what you’re likely familiar with as an ownership structure
of large companies, including the ability of any individual to easily
buy and sell shares of stock in it, is that of a public company.
Private ownership, or private equity is quite different. It is much
more akin to the local dry cleaner, restaurant or hardware store that
is owned by one or a few individuals. We also refer to this as being
“closely held.” That is essentially exactly what private equity is,
although usually with more zeros after the number.
FIRST
QUARTER COMMENTARY
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Science is nothing but perception.
-Plato
Last
quarter's commentary dealt with a broad overview of the relative
attractiveness of a number of asset classes. The analysis was primarily
quantitative and included lots of numbers, charts and graphs. This
quarter I thought it would be worthwhile to cover largely the same
topic (thereby precluding me from having to come up with another
interesting topic) but from a qualitative perspective. In other words,
last time we covered the science and this time we’ll look more at the
art.
Qualitative Decision Making
This
is a useful exercise because it shows that investing is not all hard
analysis and numbers. At the end of the day, all companies and markets
are comprised of people and people do not act strictly according to
rational logic, or at least the general view of it. If we were to
develop a spectrum with science on one end and art on the other, most
money managers would fall somewhere along, and probably toward the
middle, of that spectrum. Those that rely strictly on quantitative
computer models would argue that what they practice is purely science.
I would put forth that, at some point, every computer model is based on
human input. We can no more completely remove the human element from
these processes any more than we could pick ourselves up off the ground
by our own bootstraps. So there is, to be sure, some element of art in
the process of managing money, be it acknowledged or not.
FOURTH QUARTER
COMMENTARY,Select HERE for the full document in PDF Form
Telling the future by looking at the past assumes that conditions
remain constant. This is like driving a car by looking in the rearview
mirror.
Herb Brody
Since the most widely followed markets have begun hitting new highs in
the last few months, I’ve encountered the question of whether some sort
of calamitous comeuppance is lurking around the corner for the Dow
Jones Industrial Average and the S&P 500. The short answer is I
really don’t think so. The much (much) longer answer follows.
THIRD QUARTER COMMENTARYSelect HERE for the full document in PDF Form
Most of the change we think we see in life is due to truths being in and out of favor.
Robert Frost
Perhaps
the biggest problem with writing a quarterly commentary is that it is,
well, quarterly. So every 90 days or so it becomes necessary to write
something that is informative and, hopefully, moderately entertaining.
As those of you have been reading these for a number of years know,
sometimes this gets a little challenging because events of the previous
quarter just aren’t that interesting. In fact, since the
internet/technology/Large Cap Growth stock bubble burst in early 2000
we have largely been in a singular pattern of outperformance by just
about every equity asset class other than, US Large Caps.
Asset classes that had languished for years prior to 2000 have been on
a nearly seven year roll. The list is long and includes residential
real estate, oil, Emerging Markets stocks and Small Cap stocks. This
worked out quite well for those of us who had the foresight and
discipline to own these asset classes before they became fashionable,
providing us with handsome returns while others clung to their Large
Cap laden portfolios.
It would be easy to say that a lot changed in the last quarter, but as
the quote above implies, it’s probably more accurate to say that
perceptions have changed a great deal more than reality. So let’s start
by looking at the changes, both real and perceived. Three primary
events began to unfold in the third quarter, the collapse of oil and
gas prices along with other commodities, the beginning of the
residential real estate collapse and the beginning of the popular
rediscovery of Large Cap stocks.
SECOND QUARTER COMMENTARYSelect HERE for the full document in PDF Form
No party is any fun unless seasoned with folly.
Desiderius Erasmus
When
it comes to reviewing the last quarter, the foremost question would
seem to be, what happened? We can divide the answer into two parts. The
first is the mechanics of what happened, and the second is to identify
some of the causes.
What happened can perhaps be best likened to a roller coaster ride. We
got on the ride very excited from the great rides we’ve been on
recently, including the first quarter of this year, which was one of
the best of them all. In their rush to get on the ride some investors
ignored the “you must be this tall to ride this rollercoaster” sign
because they got considerably more than they bargained for. The ride
started off to be quite fun for the month of April and into May with
many markets continuing their rise from the first quarter by a few
percent. Around the middle of May, however, the rollercoaster had
reached its crest and began to descend into a very steep and fast
decline.
At the end
of May we started to make the ascent up another hill with relief. At
the beginning of June, however, another fast, steep decline was
underway, accompanied by some pretty loud screams. Just before the
middle of June, a number of funds and asset classes were off by as much
as 20% from their highs. In the middle of June things began a
rocket-like recovery with even the hardest hit asset classes and funds
paring the losses to “just” several percentage points for the quarter,
providing a wild ride indeed. When the ride ended there certainly
didn’t seem to be any investors yelling “let’s do it again!, let’s do
it again!”
FIRST QUARTER COMMENTARYSelect HERE for the full document in PDF Form
There are two types of people, those who divide people into two types and those who don’t.
Barth’s Distinction
While
the quote above may seem trite, it is effective in communicating our
desire for a simple framework in which to view what are often complex
topics. Most of us engage in some form of this everyday in order to
more easily understand what we observe or expect to observe. We’ve all
made a frustrated plea to the TV weatherman to simply tell us whether
it will be rain or no rain, coat or no coat.
This two part perspective extends to most areas of our lives. Good or
bad, black or white, on or off, in or out, old or new and open or shut,
just to name a few. The phenomenon has reached popular culture with a
new TV show, “Deal or No Deal.”
While simplistic, this type of analysis can be very useful. Computers
after all, work on the premise of the two state, binary world of
switches being either on or off. Take the example of a grapefruit.
Slice it top to bottom and it looks very different than if you slice it
side to side. Slice it in half at enough different angles, however, and
soon you begin to get a very accurate view of exactly how the
grapefruit is put together.
FOURTH QUARTER COMMENTARY,Select HERE for the full document in PDF Form
When the only tool you have is a hammer, every problem looks like a nail.
Attributed to Abraham Maslow
Investors in traditional stocks and bonds could well have spent 2005 at
the beach and missed nothing. Measures of what the media continues to
insist on referring to as The Market was virtually flat for the year.
The S&P 500, the measure of the 500 largest US stocks, gained just
3% for the year, not including dividends. The Dow, the index made of up
of the 30 largest “industrials” (which was probably a good measure of
something when it was started in 1884) lost 0.6% in 2005. The NASDAQ
Composite, made up of over 3,000 stocks that have nothing in common
other than they chose to list on the NASDAQ exchange rather than the
New York or American Exchanges, gained 1.4% for the year. If you bought
into the traditional investor’s version of diversification and bought
bonds, there wasn’t much help there either. The Lehman Aggregate Bond
Index, an actually quite useful index that includes just about every
bond available in the US, returned 2.4% for 2005.
The three widely quoted stock indexes and the bond index above were all
equaled or bettered last year by money market funds. Traditional stock
and bond investors could have taken the year off, put the portfolio in
cash and been no worse off for it. In other words, for these investors,
nothing happened last year.
There is no present or future, only the past, happening over and over again
- Eugene O’Neill
One of the aims of the quarterly commentaries is to bridge the gap
between what you might see in the news everyday and try to interpret
those stories in terms of how they may ultimately impact your
portfolio. This quarter that story is oil, a topic that seems to
routinely elicit intense visceral reactions that are rare for economic
topics. Everyone, it seems, has a theory on why oil prices are where
they are. That said, I’ll take a moment in advance to apologize to
clients who live in New York City, don’t own cars and rent apartments
with heat included and those outside the US, where high gas prices have
been the norm for years. The price of oil means virtually nothing to
them, directly at least. The rest of us, however, have a front row seat
to oil prices every day at the gas pump and for those of us in the
northeast with oil heat, whenever the temperature begins to drop.
Abundance of knowledge does not teach men to be wise.
-Heraclitus
Much ink, airtime and cocktail party conversation has been taken up
lately on the topic of hedge funds. Given this, the time seems to be
right to explore the topic in more detail and try to address the
question of “why shouldn’t I own some?”
A Not So Brief History of Hedge Funds
The
term “hedge fund” was originated in a 1948 article by Alfred Winslow
Jones, then a writer for Fortune Magazine. Mr. Jones argued that
investors could obtain superior performance over traditional stock
portfolios through hedging by selling short, which would mitigate
losses in the event of a market downturn. He also contended that
returns could be further enhanced through the use of leverage, or
borrowing against the portfolio to buy more securities.
Putting
his money where his mouth was, in 1949 Mr. Jones took $40,000 of his
own money, raised another $60,000 from other investors and started a
limited partnership to put his ideas to work. As a further innovation,
he put into place an incentive, whereby he would receive 20% of the
profits generated by the fund.
You’re right not because others agree with you, but because your facts are right....
-Ben Graham
Etiquette books tell us that wood is the traditional 5th year
anniversary gift. An odd way to start an investment commentary you say?
Well normally it would be, but the first quarter of 2005 saw the fifth
anniversary of the peak of the US stock markets. On March 10, 2005 the
NASDAQ Composite index (the major index most heavily weighted to growth
stocks) hit a spectacular high of 5,060. Anyone who owned the trendy
stocks of the day probably now wish they had owned wood or timber land
or just about any other hard asset instead.
I bring this up not just as a wistful stroll down Capital Market Memory
Lane, but to illustrate the point of just how far off track and carried
away the investing herd can get. Going back to that day in 2000, the
overwhelming majority of investors were thoroughly convinced that 30%
annual returns were the norm and growth stocks were the only thing
worth putting money into.
Prediction is very difficult, especially of the future....
-Niels Bohr
This year’s end brings us to a very unusual market condition.
Traditionally, as one year ends and another begins, it is a very busy
time of portfolio rebalancing. What this involves is probably the most
unintuitive part of investing, namely selling high and buying low.
Over the course of the year there are almost always asset classes that
significantly outperform others. For example, you may have a year when
stocks significantly outperform bonds. Let’s assume that we have a
portfolio that at the beginning of the year was comprised of 50% stocks
and 50% bonds (of course, a client of Sound Portfolio Advisors would be
much more broadly diversified, but this is just a simple example).
Let’s further assume that in our example year stocks went up 50% and
bonds went down 50%, so at the end of the year our sample portfolio
would now be comprised of 75% stocks and 25% bonds. In order to bring
us back to the portfolio we originally wanted, we would sell 1/3 of our
stock holdings and double our bond holdings.
A handful of patience is worth more than a bushel of brains.
-Dutch Proverb
Your home is your castle. In many parts of the country it better be,
because soon it will take a king’s ransom to afford one. It may seem a
bit odd to have your investment advisor writing about home prices. For
many people, however, their home is one of their biggest assets.
Additionally, the choice between investing directly in real estate
(through one’s home or the purchase of commercial or rental property)
or investing in a portfolio of public securities is one often faced by
investors. So it with this choice in mind that we’ll examine the
current state of the residential real estate market.
Investing directly in real estate can work for two primary reasons. The
first, and perhaps most important, is leverage. In other words you can
use other people’s money, usually the banks. It simply isn’t possible
to walk into the bank and ask for a 100% loan for an investment
portfolio at 5% for 30 years. The second factor that makes real estate
investing work is a typically long holding period. It’s not unusual for
a home or other piece of property to be held for 30 years or longer or
even pass from generation to generation.
Do
not expect to arrive at certainty in every subject which you pursue.
There are a hundred things wherein we mortals. . . must be content with
probability, where our best light and reasoning will reach no farther.
-Isaac Watts
I
generally like to use the commentary space to remind clients of the
long term nature of investing and how short term events are mere blips
on the radar screen of life and investing. This process often involves
evoking theory from some discipline that most people find arcane and
normally uninteresting.
This
quarter will be slightly different. Not to worry, however, we’ll still
cover some arcane and uninteresting theory. In fact, to some it may be
the mother of all uninteresting theory, namely probability and
statistics. The difference is a decidedly short term focus.
“A fanatic is one who can’t change his mind and won’t change the subject”
-Winston Churchill
In
last quarter’s commentary we looked at the prospect of looming
inflation and the impact on your portfolio. This time we’ll examine
some evidence, both anecdotal and quantitative, that inflation has
begun to arrive. One of the traditional harbingers of inflation has
been commodity prices. Commodities include metals such as gold, silver,
steel and aluminum, agricultural goods such as grains, corn pork, beef
and soybeans as well as cotton, timber, oil and coal to a name few
examples. The prices of commodities matter because they are the inputs
for processed goods. When the prices of commodities rise, the prices of
the goods that consumers purchase everyday must rise as well. |
