Friday, April 30, 2010

Markets, Wayne Gretzky, and Current Thinking

Though things feel a lot better today than they did one year ago, at Pinnacle we realize that we can’t get caught looking in the rearview mirror when thinking about future market performance. As the great hockey player Wayne Gretzky once said, “I skate to where the puck is going to be, not where it has been.” That wisdom is applicable to the financial markets, which are constantly discounting the future.

Here’s a 30,000 foot view of what we are currently seeing and what it means for the markets:

Economics: On a cyclical basis the economy looks very solid. Leading indicators continue to be very strong, and some of the more coincident measures, like employment, are beginning to pick up. However, structurally, many casualties remain from the financial crisis and will keep us on guard from becoming overly confident during this cyclical rally. A reduced labor force, surging global public debt burden, and subdued income growth are just a few of the structural impediments, along with increased regulatory constraints and the potential for much higher taxes looming.

Technicals: The underlying technical condition of the market continues to be very strong, with exceptional breadth (advancing versus declining issues), and almost universally positive longer-term trends in the global marketplace. The only concern at the moment is investor sentiment, which seems to be growing more bullish by the day at the same time that certain markets appear very overextended. While the potential for a correction to unfold exists, the underlying trend is still positive.

Valuation: I wrote about this recently ( and the weight of the evidence seems to imply that the market is slightly overvalued, but not enough to alter our allocations yet.

The message from all three of these is that the cyclical rally that started in March 2009 is well-supported and likely to continue. We believe that the market has a good chance to climb towards the top of our estimated target range (around 1,350 on the S&P 500). Along the way there will be bouts of volatility, and we may be closing in on one of those periods. Volatility can and will be scary, but can also be used constructively to try and augment portfolio returns through tactical portfolio adjustments.

In Wayne Gretzky’s terms, the puck may be closing in on a short-term shift in direction, but cyclically speaking we still think it pays to keep skating in the same direction.

Thursday, April 29, 2010

Would You Lend Money to Greece at 16%?

The debt crisis in Greece has taken a turn for the worse over the past week. The bailout by fellow European countries and the IMF that was supposedly agreed on weeks ago is apparently more tenuous than widely believed now that Greece has actually asked for the assistance.

As a result, the markets have responded, and not favorably – Greece’s debt was downgraded to junk status this week, causing the yield on Greek government bonds to soar. Their 2-year bonds jumped from an already staggeringly-high 7.7% last Wednesday, to 10% last Thursday, to 13% on Monday, to 15.9% yesterday!!! The market is clearly pricing in the possibility that Greece will be forced to default on its debt.

So, for those of you frustrated by the low-interest rate environment and searching for higher-yielding alternatives to paltry money markets, I ask, would you loan money to the Greek government for 2 years at 16%? After all, that’s 15% higher than a 2-year Treasury bond (see chart below). I’m sure there are some speculative investors out there, hedge funds and the like, that are in fact taking that offer. Indeed, by this morning, the yield was back down to “just” 12.3%, according to Bloomberg.

So far, the situation in Greece hasn’t adversely impacted the financial markets here in the U.S. The S&P 500 is just a few points below its recent high. However, as we know, things can change quickly, so we’ll be watching closely for any signs of a contagion effect, which would pose a serious threat to the current bull market if it occurred.

Wednesday, April 28, 2010

A Little Nuance to ETF Trading

ETFs, or Exchange Traded Funds, are similar to a mutual fund because they invest in a basket of stocks. However, one clear advantage of ETFs is that they trade intra-day in a similar manner to stocks. When trading these positions, we can monitor intra-day prices and sell or buy at an exact price whereas mutual funds are only traded at the end of the day. This has been covered in the past and has been repeatedly flogged by Pinnacle as one of many reasons to switch our US Equity holdings to ETFs. But during a recent trade, I strategically ignored this benefit to take advantage of pricing inefficiencies in a specific security.

Like any other stock, ETFs are purchased at the bid (the price a dealer is willing to sell you a stock) and sold at the ask (the price a dealer is willing to pay for your stock). The difference between the two prices is called the spread. If a stock is actively traded then the spread is very small (typically $.01) and if a stock is thinly traded then the spread is very large. When purchasing an ETF with a large spread it is very likely that the purchase price will be way above the ETF Net Asset Value (NAV). The NAV is the weighted price of the basket of stocks being bought. So what is a trader to do?

In order to avoid the large spread difference, and get a better buy price for our clients, I called the creator of the ETF being purchased and asked to buy through a process called ‘creation’. Basically, you tell the creator of the ETF a quantity to purchase, and they create new shares at the NAV. It is a very simple process but it does take away the ability to intra-day trade. The creator will fill the new order but it is for the NAV at the close of the business day very similar to a mutual fund. This was a small price to pay for the thinly traded ETF when the eventual savings to our clients were very large.

Tuesday, April 27, 2010

A New Term to Consider: Asset Allocators

Recently I found myself under deadline to complete an article that should be published in the May edition of Financial Planning Magazine. The article summarizes one of my favorite topics when speaking to audiences, which is to rebut what I consider to be the three main objections to active management. For the record, they are 1) you believe in the Nobel Prize winning theory supporting buy and hold investing, 2) you don’t believe active managers can outperform passive benchmarks, and 3) you think the active management business model is impractical. In the piece I refer to the confusion that reigns in and out of the industry regarding the roles of different kinds of investors. I routinely refer to the two camps as portfolio managers and money managers.

I define portfolio managers as the group of investors who can invest in any asset class with the only constraint being the investment policy of the investor. Portfolio managers are free to own any asset class. Portfolio managers do not have an easy to identify benchmark. On the other hand, money managers are typically constrained by prospectus to invest in only one asset class and one investment style. We know them as mutual fund managers, separate account managers, or nowadays, even hedge fund managers. Money managers specialize in investing in only one asset class, and they typically manage portfolios that own individual securities, rather than pooled investments, in pursuit of beating their easy to identify passive benchmark.

Rick Vollaro, my partner and co-portfolio manager helped to edit my article, and suggested that using the terms portfolio manager and money manager only adds to the confusion. He suggested the term asset allocators instead of portfolio managers. The more I think of it the more I think that Rick’s idea has merit. In fact, any investor who is free to own multiple asset classes without constraint is an asset allocator. The term easily differentiates us from money managers, who are not free to use asset allocation. From now on I think we should compare the roles of asset allocators and money managers. The same conclusion will be reached, which is that the public and the industry is completely confused about the roles that these investors play. The choice of whether you hire “active” versus “passive” money managers has nothing to do with the decision to actively manage your asset allocation. If you don’t manage a mutual fund or a separate account, in all probability you are an asset allocator.

Friday, April 23, 2010

Small-Caps vs. Large-Caps

Small-cap stocks have been very strong to start the year, with the Russell 2000 Index of small-cap stocks up by 18% already, versus a 9% gain for the large-cap S&P 500 Index. The performance of both is shown on the chart below. The top panel shows the total return of the Russell 2000 index (in red) and the S&P 500 Index (in blue) for the past 10 years.

The dark green line in the lower panel of the chart measures the relative strength between the two. As the green line rises, it indicates that small-caps are outperforming on a relative basis, and vice versa – if the line is falling, large-caps are outperforming small-caps.

As you can see, small-caps have generally outperformed their larger counterparts for the past 10 years. However, what we’ve noticed lately is that after the strong move over the past year, the relative strength line is back near the previous highs it reached in 2006 and 2008.

It will be interesting to see if small-caps can break through these previous highs, which would be a bullish development and would likely mean more gains versus large caps going forward. On the other hand, after 10 years of outperformance, we’re also wondering if small-caps are in the midst in some sort of topping process, on a relative basis. After all, trends don’t last forever, and 10 years is a rather long time.

If small-caps can’t break through, it would imply that large-caps are finally due to take the lead, perhaps for awhile.

Thursday, April 22, 2010

Valuation: Not Cheap, But No Bubble Yet

At Pinnacle, stock market valuation is one of the three main pillars of our investment process, and we follow it religiously. The importance of valuation can’t be overstated at market extremes, so it must be constantly monitored. However, we realize that valuation is often a very poor timing indicator, so when it’s not at extremes it tends to receive less weighting in our asset allocation decisions.

Currently, we live in a world where depending on what you read, you could get the impression that the market is anywhere from ultra cheap to extremely expensive. While that might seem contradictory, the reality is that any one data point in isolation could look dramatically different than another simply due to how it is calculated.

For example, if you want to argue that the market’s expensive, you could use the 10-year normalized price-to-earnings ratio, since it currently uses a lower earnings figure. If you want to argue that the market’s cheap, you could calculate the P/E using forward earnings, which are being upgraded at lightning speed as the economy continues to expand. The point is, the data is available to make any case you want, and it’s got to be awfully tempting to mine the data that best fits your point of view, especially if you are a perma bull or bear.

We don’t have an extreme view of valuation one way or the other at the moment. Instead, we’d characterize overall market valuation as being slightly elevated. That is not to say that there aren’t certain indicators that might be pushing towards levels that are very elevated, but to us the weight of the evidence shows the market to be modestly overvalued.

One of the ways that we track this is through our Pinnacle Composite Valuation Model (in red), which is shown measured against the S&P 500 Index (in blue) on the chart below. The composite is a simple equally-weighted model that includes 10 different valuation indicators, including price-to-earnings ratios, price-to-sales, several yield-based measures, and an intrinsic value calculation on the S&P 500.

At present, the model’s score is 4.8 (with 10 being cheap and 0 expensive). Currently, a slightly elevated market valuation means very little as we construct our overall portfolio. At some point the model will move far enough to really grab our attention, and when it does, we’ll act accordingly.

Wednesday, April 21, 2010

A Charlie Brown Forecast

Our investment committee met yesterday at the dreaded time of 1PM which means that everyone is trying to stay awake after lunch. The investment team did their usual stellar job of putting together an interesting and thorough presentation for the committee, and I’m happy to say that everyone seemed to stay awake. Towards the end of the presentation, my long-time partner, Dwight Mikulis, commented that we were making a “Charlie Brown investment forecast.” I suppose he could have meant that the after-lunch timing of the meeting reduced his understanding of the material to “Wa wa wa. Wa wa wa wa wa wa.” Or, he could have meant that our current market forecast is so wimpy that it reminded him of Lucy taking the football away from Charlie Brown right when he was about to kick it.

I’m actually sympathetic to either view of the Charlie Brown analogy. In fact, Pinnacle remains somewhat skeptical of the fundamentals underlying the current market rally. It is somewhat disturbing to see the list of problems that have not been resolved, including the high rate of unemployment, the structural problems with the length of unemployment and the number of potential employees who have given up looking for jobs, the record high amount of unemployed on government benefits, the number of problem Alt-A and Option ARM mortgages that are still sitting on bank balance sheets, the unwillingness of banks to lend and the subsequent fall in the velocity of money in the economy, the possibility of sovereign debt defaults in the EU, China’s potential property bubble and the potential for a sickening bubble-busting event, the continued fall of new housing prices, etc. Not to mention the structural problems of too much debt, higher taxes, higher regulations, and on and on and on.

These concerns are countered by the fact that the economy is now clearly expanding with GDP growth numbers confirming that the recession (in the consensus opinion) ended last summer. Inventories are being restocked, new unemployment claims are falling, and profits are surprising to the upside for the fourth quarter in a row accompanied by increasing revenues. The market remains amazingly resilient as even last week’s news of the SEC suit against Goldman Sachs failed to significantly derail the bull market. There is plenty of pessimism around to support the wall of worry needed for all bull markets. So our forecast is for the market to drift higher with the caveat that there are lots of reasons to worry. So call it a Charlie Brown forecast if you must. I still don’t think it is appropriate to be wildly bullish or bearish in the current market environment.

Tuesday, April 20, 2010

Atlas Shrugged – A Three-Paragraph Book Review

As any of our analysts will tell you, the amount of technical reading needed to keep up with the markets is enormous. We have daily, weekly, and monthly investment research to digest and it leaves little time to read (or write) books. However, recently I decided to get caught up on some of the reading that I have been putting off, and the book that made it to the top of the list was Atlas Shrugged, the famous book by Ayn Rand. The book is about Rand’s philosophy of objectivism, which holds that the proper moral purpose of one’s life is the pursuit of your own happiness or rational self-interest. The story is about a powerful group of industrialists who go on strike and retreat from the world until the rest of the world sees the error of their ways. The oath to join this powerful group says it all, “I swear – by my life and my love of it – that I will never live for the sake of another man, nor ask another man to live for mine.” To say the least, the book has become a rallying cry for those who believe in free markets.

For the past two years I have been hearing more and more people in the financial industry referring to this book, and now I know why. Ayn Rand is perhaps most well known for being one of Alan Greenspan’s early “gurus” and a major influence on his philosophy about free markets. Knowing that the country is about to focus on regulating financial markets (see last Friday’s sell-off on news of the $1 billion lawsuit against Goldman Sachs) where the rhetoric will be all about the social good, Atlas Shrugged certainly becomes a very relevant book to read. It’s worth mentioning that my version was 1,168 pages long (with no pictures) and throughout the book Rand’s characters give several speeches that are so long that they are exhausting to read (I will never admit to skimming any of them). Once you get started, the book is a surprisingly good read. It’s a surprisingly good story. Here are a few other insights into the book you are not likely to get on Wikipedia.

The villains in the book are unbelievably evil. They are witless, spineless, and totally and completely without any redemptive qualities. The heroes of the book, the industrialists, are saintly in their goodness. Clearly Rand wants us to be able to tell the good guys from the bad guys. The book was copy written in 1957, and the characters all smoke cigarettes like chimneys. It is very weird to read. Every scene involves someone, good or evil, chain smoking. Finally, the heroes, the captains of industry, who are the protagonists of the book, are industrialists who run railroads, copper mills, steel mills, and manufacturing plants of all kinds. Considering how the American economy has evolved, these swashbuckling leaders of industrial production seem strangely out of place.

Next up on my list: Too Big To Fail by Andrew Ross Sorkin.

Friday, April 16, 2010

Who and What is Sharpe?

At a recent investment team meeting, I commented that all of our portfolios have great Sharpe ratios on a 1 year time frame. The other members on the team could hardly contain their joy when they heard the news. Although, with all due respect to other investment nerds out there, I think the majority of people in this world would come back with the reply, ‘What’s Sharpe?’ Well, William Sharpe was a Nobel laureate in Economic Sciences who developed the Sharpe ratio to measure risk-adjusted performance. The formula for the ratio is simply the portfolio return minus the risk free rate (we use 6 month treasury bills) divided by the standard deviation of the portfolio. This ratio will then tell us if the portfolio’s returns are due to smart investments or undue risk, which I would argue becomes very important in this market environment.

Actually, Goldman Sachs would back up that claim as well. In their ‘best ideas for 2010’ they recommend buying ‘High Sharpe Ratio Stocks’. They studied high Sharpe stocks back to 1999 and found that they offer a strong track record against the S&P 500. So let’s see how Pinnacle has done on the 1 year time frame.

Pinnacle portfolios had a Sharpe ratio that was between 3.5 and 3.7. We then looked at other Sharpe ratios in the investment world to see if this was a good number or not for the past year. We started with the SPY (S&P 500 SPDRs) and found a Sharpe ratio of 2.56. Next, we found the Sharpe for well known diversified mutual funds: American Balanced had a Sharpe of 3.02, Dodge and Cox Balanced had a Sharpe of 3.15, and Leuthold Core had a Sharpe of 2.14. Finally, we found the Sharpe of XME (Metals and Mining ETF that performed very well over the last year) to be 2.82.

When looking at the risk adjusted Sharpe ratio, it is very clear to us that we have been managing our portfolios due to smart investments, and not undue risk.

Thursday, April 15, 2010

How to Crush Your Benchmark Returns

It seems to me to be more than a little ironic that in a 12-month period where Pinnacle has set records for absolute portfolio gains, where our clients are basically thrilled with the recovery of their personal balance sheets, and where portfolios have fully recovered to make new highs since the beginning of the bear market in October of 2007, that I find myself worried about our returns relative to our benchmarks. I have written at length about the vagaries of choosing a benchmark for diversified portfolios, and how outperformance can be made to appear or disappear based on randomly adding or subtracting asset classes from the benchmark portfolio.

Nevertheless, our managed accounts portfolios are trailing their benchmarks in terms of total return for the twelve month period. While this underperformance has occurred with less risk or volatility than the market (our risk-adjusted returns still look great compared to both the S&P 500 and cash), it seems to me that average investors remain focused on short-term returns. Therefore, it bears our scrutiny. With that in mind, I thought I would clear up this relative performance question by sharing the strategy that is most likely to crush our two asset class benchmark (S&P 500 Index and Barclay’s Aggregate Bond Index) going forward.

First, we need to abandon any approach to value investing since market values are a notoriously poor market timing indicator. When focused on shorter-term time horizons, any attempt to evaluate market valuation or the economic cycle is basically a waste of time. Next we need to abandon multiple asset classes in our portfolios and only own the S&P 500 Index in our managed accounts. Since this is the risk proxy in our benchmark portfolio, we will avoid the risk that international stocks, commodities, real estate, and other risk assets will underperform over any short-term time frame. Next, we need to make large asset allocation bets so that we maximize our infallible investment forecasts. Taking the portfolio to 100% cash or 100% equity will enable us to crush the benchmark portfolios at will (as long as we are always correct in our assessment of market direction). Just to be clear, we have no intention of doing any of the above since we believe that it constitutes a high risk, if not foolish, investment philosophy. I just thought it would be fun to see it on paper.

Wednesday, April 14, 2010

Bottom up Security Analysis: Currency Matters in International Investing

In a recent blog I wrote about the breakout in the Japanese Yen versus the US Dollar, (, I described how a lower Yen may be a catalyst for a breakout in Japanese stocks. The primary reason a lower yen may help the Japanese equity market is that the Japanese economy still has a heavy reliance on exports. A lower Yen should mean an increase in exports which leads to higher earnings. It would also help to combat the deflationary conditions that have existed in Japan for decades.

In Pinnacle portfolios we own limited Japanese exposure at this time, but what we do own is a security that is not hedged against a falling yen. An un-hedged security has served us well for some time, but now it appears the tide may be shifting.

Today I embarked on a search for a security that would give us exposure to Japanese stocks, but also protect assets from a falling yen. After calling the managers of our current holding and running multiple filters on other securities in the Japanese equity space, there appears two ways we could eliminate the currency exposure we currently have.

One would be to leave the un-hedged fund (SPARX) alone and buy a security that makes money if the yen were to depreciate. There is a security available that bets against the yen (YCS), but it has numerous drawbacks. The first drawback is that the Exchange Traded Fund is leveraged, which increases the risk and the tracking error of the instrument over time. The second is that this approach requires more of a capital commitment since we would have to purchase both SPARX and YCS to get the net exposure desired. The third is the construction of the ETF makes it somewhat tax inefficient.

Our other option is the exchange traded fund DXJ (Wisdomtree Japan Hedged Equity), and it appears to be a much more efficient way to gain the desired result. DXJ owns Japanese stocks and hedges out currency exposure, and does this at a cheaper expense than what we currently own.

Tomorrow we’ll meet and talk about what we own in the Japanese space, and whether we should make a switch to the hedged security. We may or may not decide to pursue this particular investment after debating the pros and cons of making a switch at this time. Regardless, bottom up security construction is considered an important part of what we do, and meetings on security construction are a normal part of our process.

Friday, April 9, 2010


MACD, which stands for Moving Average Convergence/Divergence, is a tool used to determine momentum in a securityor index. To calculate the indicator you subtract the 26 day Exponential moving average (EMA) from the 12 day Exponential moving average (EMA). In essence, this allows the investor to see if the faster moving average (12) is above or below the slower moving average (26). Additionally, a 9 day EMA of the MACD is plotted to identify trade signals. With the MACD and the 9 day EMA, there are various ways to generate trade signals including crossovers and divergences. At Pinnacle, we typically monitor the MACD of the S&P 500 to assess the momentum in the broad market.

This chart is from 4/9/09 to 4/9/10. The S&P 500 is shown in the top panel along with the 12 day EMA in pink and the 26 day EMA in green. So when the MACD is created, which is the white line in the bottom panel, it is above 0 because the 12 is higher than the 26. The 9 day EMA of the MACD is also plotted in the bottom panel with a red line. With the index, the indicator and the trigger line plotted we can now assess the momentum in the market.

The first concern is the negative divergence between the S&P 500 and the MACD as indicated by the two white arrows. The S&P 500 is continuing to make new highs while the MACD is starting to rollover. The second concern is the MACD is starting to crossover the 9 day EMA to the downside which would be an additional sell signal. The last time a negative crossover occurred was right at the January peak so we will be keeping an eye on this indicator.

Thursday, April 8, 2010

Quick Update on Equity Markets

So far this year US small cap stocks are leading the charge. Small Cap stocks are traditionally companies valued below $1 billion. They are up an impressive 12.23% year to date through 4/7/10.

IWM (Russell 2000 Exchange Traded Fund) +12.23%

SPY (S&P 500 Exchange Traded Fund) +6.59%

EFA (MSCI EAFE Index) +2.15%

EEM (MSCI Emerging Markets Index) +4.48%

Generally considered dollar strength beneficiaries, the nice rally in the green back has certainly provided strength to the small cap stocks. Meanwhile, the European stock proxy (EFA) has seen slight underperformance due to the Euro weakness. For instance, the DAX Index which is comprised of 30 selected German Blue Chip stocks is up 3.6% this year in local currency (Euro), but is down 3.42% in US Dollar terms. Additionally, emerging stocks have failed to keep pace with US markets.

All in all, this pattern of outperformance in small cap stocks can be very comforting to bullish investors. Outperformance reflects investor comfort in risky positions. Coupled with a bullish trend there is still reason to anticipate more gains.

Wednesday, April 7, 2010

Greek-German Spread Update

Below is a chart that we discussed during our Inside the Investment Committee presentation. It is the yield of a 10 year Greek bond (orange line), the yield of a 10 year German bond (white line), and the spread between the two (yellow line in the second panel). The German bond is generally considered the safest bond in the Euro zone, and the spread allows an investor to gauge the risk level in other countries. When the spread moves higher it means that the yield on the Greek bond is moving higher when compared to the German bond, or the country is seen as riskier. And as a refresher, when yields move higher bond prices fall and when yields move lower bond prices rise.

When we showed the chart at the beginning of March the spread had been narrowing, or Greek bond prices had been rising when compared to German bonds. That was due to rising expectations of a bailout for Greece by the other Euro member states. However, over the past month the bailout has not moved forward and the spread has jumped right back to the highest point since the adoption of the euro. The bond market is definitely signaling concern over Greece’s ability to reign in this debt crisis and avoid defaulting on their bonds.

And that brings us to the equity market. This latest move higher in Greek to German spreads has been of little concern to equity traders and this has certainly intrigued me. During the last spike in January, equity markets sold off close to 10% as fiscal fear spread throughout investing circles. So are we worrying too much about the fallout from sovereign default, or are equity traders the last ones to get it?

Tuesday, April 6, 2010

Short-Term Energy and Summer Fuels Outlook

The Energy Information Administration (EIA) has released their projections for West Texas Intermediate (WTI) crude oil, regular-grade motor gasoline, and Henry Hub natural gas. The EIA provides information and data covering energy, and prepares analyses and reports on topics of current interests. The projections for WTI crude oil spot prices have changed very little over the last five Outlooks, and they expect prices to average $81 per barrel this summer. Also, they project prices to average $85 per barrel by the fourth quarter of 2011. The strong global economic recovery will help keep prices firm over the next few months while several outside factors including the strength of the recovery and OPEC production could impact their projections.

As you may have noticed over the past few months, gasoline prices have been steadily climbing towards the $3 per gallon range. Well, the EIA forecasts that regular-grade motor gasoline retail prices will average $2.92 during the summer driving season and prices could even exceed $3 at various times during the season. Although consumers seem to have taken the steady rise in prices in stride, they are becoming increasingly burdened by the additional cost. If you recall the June 2008 high in price was $4.10 per gallon but I don’t think we need to see anything close to that level before the Federal Reserve starts to worry about commodity inflation.

For those interested in the full report it is found at the following address:

Friday, April 2, 2010

Keep an Eye on the Yen

The relationship between the euro and the U.S. dollar has captured most of the headlines recently, and that’s understandable given the problems with the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), and the fact that the trade-weighted dollar index is so heavily weighted toward the euro (about 58%). But lately we’ve been watching the relationship between the dollar and the Japanese yen with a lot of interest as well. We hold small positions in our more aggressive strategies in Japan, mostly because of attractive valuations and because their equity market has underperformed so miserably that it may be due for at least a cyclical “mean reversion” trade. With the right catalyst we think Japan's equity markets could have significant upside even with the backdrop of poor demographics and much less robust growth than other countries.

The catalyst we have been waiting on is a weaker currency. One of the main problems with the Japanese economy for more than a decade has been a bout of chronic deflation. A weaker currency can help to counteract deflationary forces. Having a strong currency in recent years has hurt their economy, as well as stock prices. But the yen has recently been losing ground to the dollar, and appears to have broken above an important downtrend line on the news of a recently enacted fiscal stimulus package. With the largest percentage of government debt to GDP among developed economies, the currency has reacted negatively to the latest round of spending. The catalyst may have arrived.

Thursday, April 1, 2010

Tony Boekh on Sound Money Management

The Gloom, Boom, and Doom Report is one of our favorite pieces of institutional research. Written by Marc Faber, it is one of the most stimulating and contrarian reads you are likely to find. I highly recommend it. In the March letter, Faber quotes from Tony Boekh’s upcoming book, The Great Reflation. Boekh is a former lead editor for BCA Research, another of our favorite institutional reads. Sometimes you read something that is so good that you just have to share. Here is Boekh discussing portfolio management:

From my 40 years in the business of trying to understand and predict markets, I cannot emphasize strongly enough the importance of having a mental framework of how markets work and how to integrate into this framework different indicators, which reflect the various forces that drive markets. Without that, the investor is like a boat on the ocean without a rudder, with the direction determined by which way the wind is blowing. In the world of investments, Wall Street blows by far the most wind, and it does not have the investor’s well-being in mind, only profits and bonuses for employees and shareholders of the firms there.

A framework of analysis for understanding markets is not the same as building a model or set of indicators fitted to back data. I can assure you, from a lot of experience that they always break down. An eclectic approach that is based on common sense, strong logic, and objective data, balanced by right-brain intuition and lots of curiosity, is what works best. The investment world will never be deterministic, never amenable to scientific models, at least for any period of time. Some approaches work well in some periods, other approaches in other periods. Successful investors not only know how to think outside the box but, from experience know what to pay attention to in each market environment.

What a beautiful statement of an investment philosophy that perfectly matches our own. As active portfolio managers, we are always trying “to think outside of the box” and to “use our experience to know what to pay attention to in each market environment.” Thank you, Tony, for saying it so eloquently. Needless to say, I will be buying his book ASAP.