“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
Betty Crocker introduced Hamburger Helper in 1971. You took chopped meat and added it to the eponymous mixture of macaroni* and spices. In essence, you took the good stuff, the ground round, and added filler to stretch out the meal. Much of active management works the same way.
There is a tendency among market commentators to seize upon a data point and declare that hellfire and brimstone are about to come raining down. They blow things out of proportion. They see fire when they should be on the lookout for ice. A recent example is auto loan delinquencies. This looks bad:
Here’s a typical reaction, by which I mean, one completely lacking in perspective:
- The number of auto loans at least 90 days late exceeded 7 million at the end of 2019 hitting the highest level in decades.
An old boss of mine would have told them to stop hyperventilating.
Of course auto loan delinquencies are growing and hitting the highest number in decades. Population grows. Loans grow. Delinquencies grow. We need some context here. Continue reading
I am now The Market Cyclist. This blog will continue to feature posts on markets and investing. Afterall, Market is in the title (and markets do have cycles). I anticipate adding personal finance related content and other, non-finance related, content. The change comes because my role has expanded beyond investing. As an advisor, I help people in many aspects of their financial lives.
Like anyone who moves I’ll want you to have my new address. It is: themarketcyclist.com The old URL, globalinvestmentstrategy.wordpress.com, will redirect to the new one, so no worries there.
I would like to thank everyone who has followed me or visited this blog over the last several years. I hope you come along for the ride.
While having lunch with a client recently, I asked about his attitude towards risk. His half-joking response was that he would like high returns with no risk. I’ve heard similar sentiments echoed many times down the years. We all want the magic pill, weight loss without dieting or exercise, gain without pain.
Because we all want that, we fall prey to the idea that there are ways to engineer returns without having to endure volatility. It’s why investing with Bernie Madoff was so attractive. He proffered a long term record of over 10% per annum with few down months and no down years. It didn’t end well. Continue reading
Remember that the best hitter in baseball this year will fail 65 percent of the time.
— George Will
Mookie Betts hit .346 in 2018, failing 65.4% of the time. Mr. Betts reached base more often than his batting average indicates due to walks. His on base percentage (OBP), was .438, decreasing his failure rate to about 56%. Stocks, in the long run, have a similar failure rate.
Recent research from Hendrik Bessembinder of Arizona State¹ shows that from 1926 to 2016 just 42.6% of stocks provided lifetime returns that beat one month treasury bills. Fifty seven percent of stocks destroyed value over that ninety year span. If such a low percentage of stocks outstripped the return of a t-bill, how is it that stocks provided an 8.5% return over t-bills from 1926 to 2015? Back to baseball.
Batting average is indicative of skill, but it’s incomplete. It omits extra base hits. Slugging, the ability to hit doubles, triples and home runs, increases the value of a player immensely. In 2018, a high slugging percentage made the guy with the 56th highest batting average, a .270, the fifth most valuable batter. Conversely, just 5 of baseball’s sixteen .300 hitters made it into the twenty most valuable hitters when extra base hits are considered. In statistics, this outsize contribution per hit is called skewness. Continue reading
As 2018 fades to black, we find ourselves in more volatile markets than we have seen in a while. Multiple large daily drops, at times followed by enormous upswings like the 5% surge on December 26th, are par for the course. Almost all asset markets are negative in the year to date, even former stalwarts of positive return like US stocks and high yield bonds. No developed country stock market is up for the year. Emerging markets, whose outcomes are more varied, are also in the red thus far, though change may be in the air; seven have been rallying for the last three months. Treasury bonds are now positive in reaction to the equity selloff. Short and intermediate corporate bonds have also eked out small gains.
Markets are nervous. Are problems coming down the pike or, as FDR would have put it, do we have nothing to fear but fear itself? No one can say in the moment what is driving the volatility and the selloffs. History will judge. What we can say is that the stock and bond markets are sending us signals, signals about participants’ beliefs regarding economic and political developments. These signals are hard to read, cloaked in noise as they are. We don’t yet know the answer, but we do know that concerns can be overblown and that overreacting to volatility can be counterproductive.
Below are some issues we have seen raised in the press or by market participants. It is not a comprehensive list, nor does it imply a clear direction. Don’t read too much into it; it is far easier to enumerate a list of fears than to see the opportunities. Those will come in time. In the meanwhile, don’t let volatility drive you off course.
- Fed tightening: The US central bank has raised the funds rate upper bound to 2.5% from just 0.25% in December 2015. It has also been shrinking its balance sheet by letting treasury notes and mortgages it holds mature rather than reinvesting all the proceeds.
- Yield curve inversion: Some short term bond yields rose above longer term yields earlier in December causing a yield curve inversion. Yield curve inversions have often preceded recessions, though it has taken as long as two years from the initial inversion for the recession to arrive.
- US tax cuts boosted earnings for many firms in 2018. In 2019, there will be no such boost. Tax rates will still be low, but the comparison will be apples to apples. Earnings growth will have to come from business growth, not outside forces.
- Leverage in the US corporate sector is very high, as it is in the rest of the world. There may not be a systemic risk from this debt pile, as there was ten years ago, but higher rates and slower growth could strain many companies.
- China’s growth is decelerating. The easy gains from urbanization and industrialization are petering out and the trade war may be taking its toll. Debt issuance has been high for the last decade, much of it for uneconomic projects. If the government takes on the distressed debt, it will diminish its capacity to stimulate the economy. Chinese equity markets have been among the worst performers this year. Will China follow Japan into stagnation or is there a productive way to reignite growth?
A theme of the past several years has been the need to protect yourself from the bond market selloff, a selloff that seems to have arrived. The idea that you should protect against this has led to the suggestion that you should buy floating rate funds. This sounds like a great idea. Maybe yes, maybe no.
There are two very different kinds of floating rate funds. The first kind, exemplified by ETFs like FLOT and FLRN, hold investment grade floating rate bonds issued mostly by banks. Modest issuance by other sectors makes up the balance. Loan funds are also floating rate, but that’s where the similarity ends.
The investment grade funds will provide you with yields tied to short term rates like LIBOR. FLRN’s yield fully reflects the Fed’s tightening cycle. Each point on the chart shows the yield you would have earned over the prior 12 months. Looking forward, the fund is paying 2.6%, versus the current funds rate of 2.2% or 1.94% more than it was paying before the Fed started raising rates.
Loan funds pay a juicier yield that is tied to LIBOR, just as in investment grade floating rate funds. That’s where the similarity ends. The yield of the SRLN ETF, where SRLN stands for senior loans, did not follow the Fed as rates rose. It’s up just 0.15%, from 4.29% to 4.44%.
Loan yields have barely budged as the Fed has tightened
“Markets fluctuate.” That was the entire comment by Ace Greenberg, the CEO of Bear Stearns, in a special issue of Institutional Investor magazine dedicated to opinions from the great and the good regarding the causes and consequences of October 1987’s 508 point/-23% market crash. Others said more. Much more. None of it is memorable. I suspect that (almost) all of it was wrong. We don’t know in the moment what is causing markets to move, despite what they say on CNBC. Nor can we foresee the ramifications of large and volatile market movements. Sometimes, as in 2008, they are profound. Other times, like in 1987, they are speed bumps, nothing more. Ace understood that.
We don’t yet know if we are experiencing fundamental changes in the markets or the economy. We do know that markets are likely to stay volatile for a time. Volatility has a tendency to stay high once it spikes.
Volatility remains elevated for a while before it mean reverts
Given that our understanding of volatile market events is limited in real-time, I have found that making sudden changes in investments or asset allocations is not helpful. What has worked best for me through episodes like this, over many cycles, has been to assess the landscape and, if I can discern a change in the market environment, to look for opportunities.
The other thing that I have seen work well is rebalancing back to a target portfolio. If a downturn becomes deep, you want to be exposed to equities for the rebound. It’s an easy thing to say and a difficult thing to do. Historically, it has been the correct move.
We’ve had a Toyota RAV4 for over eight years now. It’s been great because it’s reliable and can hold a ton of stuff with the seats down. However, every once in a while we receive a recall notice from Toyota, because while it’s great, it’s not perfect.
The last time we received such a notice it was related to the rear seatbelts being improperly anchored. I went to the dealer service facility and almost as soon as I arrived, a couple of mechanics started slapping devices resembling Denver boots on each of the four wheels. An Indy 500 pit crew couldn’t have done it much faster.
I asked: “What are those for?” They said: “Oh, we’re checking to see whether your wheels are properly aligned.” I suppressed my inclination to point out that I was a) there for a recall relating to my rear seatbelts, b) was not interested in having them do an alignment, since it was sure to be overpriced. Luckily, the wheels were aligned properly so I didn’t have to deal with it. Continue reading
A number of years ago I took over a portfolio that held corporate bonds from both developed and emerging markets. As I looked through the holdings a name popped out at me, Ipiranga. I turned to my credit analyst and said something like: “Hey Mike, what the hell is Ipiranga? I never heard of it.”
I had been investing globally for ten years, but my focus was on sovereign bonds or sovereign linked bonds up until then. I bought the bonds of utilities, banks or telecoms that would be supported by the government if trouble came calling. Ipiranga wasn’t that kind of company. Continue reading