J. Lyons Fund Management, Inc. Newsletter
||Posted August 12, 2013|
The Market: At (and On) a High
Fed-induced liquidity has resulted in a still-sputtering economy...and a sketchy market at all-time highs.
While it is easy to get impatient with managers when the stock market is making new highs yet your portfolio is lagging, the most constructive and objective reaction might be to search for the reason why. As noted recently in Bloomberg Businessweek,
“Hedge funds lost 1.4 percent in June, the most since May 2012, paring the gain in the first six months of 2013 to 1.4 percent, according to data compiled by Bloomberg. Hedge funds that use computer models to decide when to buy and sell securities slumped 6.3 percent last month, extending losses for the year to 7.1 percent, and emerging-market stock funds declined 6.6 percent, leaving them down 9.7 percent in 2013. Hedge funds have trailed the MSCI All-Country World Index for five of the past seven years as managers have struggled to predict markets amid intervention by central banks across the globe.” (emphasis ours)
I would point out that although it is understandable for investors to desire all that is offered in a market advance, it might just be a red flag when some of the smartest minds in the business have such lackluster performance. It may also be a red flag for money managers regarding the future of stocks when investors become so impatient in the same environment.
The last such time both such "red flags" were raised was in 1998-99 when the siren’s call of the dot.com stocks had clients insisting on "just investing in the Nasdaq 100 and forget about watching things". One was fortunate not to succumb to that temptation as those that did lost half their money rather quickly.
Disclaimer: While this study is a useful exercise, JLFMI's actual investment decisions are based on our proprietary models. Therefore, the conclusions based on the study in this newsletter may or may not be consistent with JLFMI's actual investment posture at any given time. Additionally, the commentary here should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies.
Now however, the reason for "flag raising" is somewhat different in our opinion at least than in the late 90’s. It appears that the stock market has caught "entitlement fever". The primary symptom of that is that in the absence of good news, bad news becomes good news because the bad news perpetuates the assurance of such Federal Reserve "entitlements". In fact, the market appears to be "on a high" as a result of this addiction.
It seems rather clear that the market has been continuing its ascent, despite the fact that the economy has been languishing, only because of the billions of dollars (currently $85 billion each month) that have been pumped ostensibly into the economy since 2009. I say ostensibly because in fact, that money, by default, has been the driver of the financial markets instead of the economy. And I say "by default" because there has not been a great demand by business for borrowing those funds nor an appetite for lending by banks. In addition, with interest rates so low, less and less of this money is flowing into the bond market, leaving the stock market as the clear, default prime beneficiary of the Fed’s entitlements.
As but one indication of business’s slack demand, see the National Federation of Independent Business Optimism Index. Not only is the current reading well below its long-term mean, but the index has remained below the historic "normal" range throughout the so-called recovery from the financial crisis.
"We have tried spending money. We are spending more than we have ever spent and it does not work….We have never made good on our promises…I say after eight years of this Administration we have just as much unemployment as when we started…And an enormous debt to boost." - Spoken by Henry Morgenthau Jr. to a group of his fellow Democrats on the House Ways and Means Committee in May of 1939 as the Great Depression continued. Morgenthau had recently concluded serving as Secretary of the Treasury for eight years under his best friend, Franklin Delano Roosevelt.
Dependence is the result of any addiction and the stock market has now become dependent on the largess of Federal Reserve Chairman Ben Bernanke -- or whoever is calling the shots and injecting $85 billion into the economy every month. It should be noted that these funds by the way didn’t exist in the economy the day before they were injected. Paradoxically as a result, when the economic news is anemic enough to assure the continuation of such "quantitative easing" (note they don’t call it "qualitative" easing) and Bernanke confirms it, the stock market is assured of more fuel and the rally continues. Perfectly clear, huh? It’s bad enough to be continuing this easing when thus far it has had minimal effect (as in 1939). The important question that looms is what happens when it stops. It took WWII to assist the recovery from the Great Depression. Such an event is certainly not on the wish list now.
See the following chart for evidence of this "minimal effect". It indicates that the plight of the most employable age group in the U.S. has hardly improved since all this easing began. Furthermore, any minor improvement is overstated as it is estimated that total unemployment (as measured by the "U-6" rate which takes into account those who are so discouraged that they have given up looking or have taken part time work) is 14.6% rather than the current stated 7.5%. In fact, the "U-6" rate increased by a half percentage point in June. Suffice it to say, it is a real stretch to say there has been any significant improvement as a result of the vast sums of funds squandered in such economic "entitlements", let alone as a result of the confidence-sapping, business-hostile fiscal policies of the current administration.
Additionally, 4.4 million Americans -- sadly 37 percent of the total unemployed population -- have been unemployed for 27 weeks or longer. Not only that, but the lower half of the income distribution, the very group that the Administration and the Federal Reserve claims they are trying to help is suffering the most. This group got hit the hardest when the real estate bubble burst because they were the most highly leveraged and had the most speculative mortgages. Now, on top of that, their income has declined in each of the past five years and the group is suffering from 15% unemployment. Not sure that Henry Morgenthau’s lesson is remembered!
Active managers try to analyze the economy and/or interpret the messages emanating from the internals of the financial markets as guidance for their money management strategies. Perhaps they can be faulted for misjudging the failure and, perhaps, the outright ineptitude of both the current monetary and fiscal policies in responding to the Great Recession. Many managers did correctly predict that the suggested fiscal policy -- or lack thereof -- would not succeed. However, perhaps the greatest difficulty arose for money managers in their failing to anticipate the extent to which bad economic news would turn out to be good news for stocks. However, if premature caution proves to be as beneficial now as it was in 1999, then once again the failure of not being buy-and-hold managers will be well justified.
John S. Lyons
The commentary included in this newsletter is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.