March 15, 2013
By Steve Blumenthal
Book Smarts and Street Smarts. Often lacking in the investment world is a knowing sense of logical human behavior and how behavior likely plays out at points of significant inflection. The great investor connects the dots before the move. Some people are book smart but find it difficult to find their way from point A to point B. Some people have an exceptional street smart IQ but can’t make their way through an academic exam. I believe the successful investor has a rare combination of both, and perhaps most importantly, the discipline and guts to stick to his conviction.
Who is doing this with money on the line? I frequently read hedge fund research, independent sell side research and a generally bullish biased Wall Street research. Everyone has an opinion and, of course, no one is guaranteed to be right. I find myself far more interested in what the person with significant skin in the game has to say.
This week’s On My Radar features two such individuals. Mutual fund manager, John Hussman, with intelligent commentary around valuations (yes, they are high) and hedge fund manager, Kyle Bass, saying that “the AIG of the world is back” (hint: Japan).
On the other hand, today Alan Greenspan made the media rounds singing, there is “No irrational exuberance, stocks undervalued”. Who got this right the last time? I found this simply unbelievable. Source: http://money.cnn.com/2013/03/15/investing/greenspan-irrational-exuberance/
1. Hussman – Two Myths and a Legend
The Hussman piece is largely about valuations and forward return expectations. Zero in on Myth 2: “Stocks are reasonably valued” for a sound discussion on valuation. There are several outstanding charts such as the following: Note the high percentage of stocks shows PE to forward earnings is expensive (red circles 2002, 2007 and today). His message regarding current valuations is that the market is richly priced.
Source: Morgan Stanley (via Hussman via ZeroHedge)
Quoting Warren Buffett, “In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%… Maybe you’d like to argue a different case. Fair enough. But give me your assumptions. The Tinker Bell approach – clap if you believe – just won’t cut it.” – Warren Buffett, “Mr. Buffett on the Stock Market,” Fortune Magazine 11/22/99
Hussman shares, “the ratio of market capitalization to GDP suggests a likely 10-year total return for the S&P 500 of about 3%, which is about the same estimate that we obtain from a much broader set of fundamentals. We estimate that the first five to seven years of this horizon are likely to be associated with zero or negative overall returns for a passive investment in the S&P 500”. Click here to read Two Myth’s and a Legend by John Hussman.
2. Kyle Bass – On shorting the Japanese Yen. Kyle presented at the Myron Scholes Global Markets Forum: “The Coming Crisis in Japan”
Quoting Kyle, “Let’s just clear this up again. The ECB is going to buy bonds of bankrupt banks just so the banks can buy more bonds from bankrupt governments. Meanwhile, just to prop this up the ESM will borrow money from bankrupt governments to buy the very bonds of those bankrupt governments.”
Please note that the video runs long. Kyle begins at the 7:40 mark and there is a valuable Q&A that begins at the 50 minute mark. http://media.chicagobooth.edu/mediasite/Viewer/?peid=f15d95d054e8442ab0cc1c60321383101d
Also, here is a link to a piece from Zero Hedge: http://www.zerohedge.com/news/2012-11-17/kyle-bass-falacies-such-mmt-are-leading-sheep-slaughter-and-we-believe-war-inevitabl
Last November, I recommended to short the Japanese Yen and suggested to structure the trade within a broadly diversified portfolio. Kyle’s best trade idea is to own gold in Yen. Essentially, he is recommending going long gold and short yen. Of course, he is doing it with significant leverage. Something you won’t be able to do unless you are a very large institution.
Ultimately, I believe we are in for a bumpy ride as we work our way to higher dividend yields, higher interest rates and much better valuations (the current Shiller PE of 23.31 simply is not a good starting point to invest. Risk is elevated at such starting points).
If I’m wrong and your equity exposure is risk protected (i.e. collared option strategy) from time to time, I hope at the very least you’ll sleep better at night while still participating in the upside (outside of a relatively small insurance cost to protect your long-term equity exposure). If I am correct in my view, then I believe you’ll be in far better financial shape and better positioned to take advantage of future opportunities from a much more attractive valuation level. To me it is about making money more than it is about being right.
See Trade Signals for risk on / risk off tied to investor sentiment extremes.
Have an outstanding weekend. I’ll be in Beverly Hills at the Milken Institute April 28 – May 1 and in San Diego at the SSG Advisor Conference May 1-3. I hope to see you if you are in the area.
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
steve@cmgwealth.com
610-989-9090 Phone
PS: When I look at the world, I try my best to view it from a probability perspective. I read endlessly and have access to some outstanding hedge fund and independent investment research. Fortunately, if you dig deep enough, you have access to a great deal of information on the internet. This certainly wasn’t the way it was in 1984 when I started in the business.
I believe we are in a challenging low return environment and that most individual investors hold higher return expectations; those expectations will not be met and investors will seek a better solution. In this, I see an unprecedented opportunity for you to grow your advisory business.
With this piece I try to share some information that I have found to be important. To me the evidence is clear, but I most certainly could be wrong.
Whether I am correct or incorrect in my thinking, my overriding belief is that you can create and manage successful portfolios for the period ahead. This environment requires more work (mixing a diverse set of risk drivers and more active beta hedging) than exists in a secular bull market cycle, but also offers you the ability to separate yourself from the 98+% of your competition that is heavily weighted in the old 60/40 stock/bond construction model.
The good news is that the investment opportunity has been greatly expanded and solutions exist. While risk is an inescapable companion in the investment process, I believe it can be quantified and minimized by expanding the asset classes you include in your portfolios.
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