Investors have been looking for a silver bullet for years; a low risk, smooth return solution. Bernie Madoff solved that need with a Ponzi scheme, along with other scammers too numerous to mention; but are highlighted in the CNBC series, “American Greed”. JPM pleaded guilty to a felony and was fined for being at a minimum, complicit; in the Madoff scam- perhaps the silver bullet is just too tempting. MCS has seen numerous examples of the too good to be true strategies blow up in investors faces and accounts just in the last few years. While protecting principal is always important, we believe it will become the pre dominate theme for investors during the next five years. Central Bankers in the U.S. temporarily and artificially increased some asset values in the market, especially large cap stocks; and primarily about 10 or so companies that became seriously overvalued. This temporary condition is over. What is the proof that this is over you may ask? Let’s go through some bullets:
- Global markets have performed horrifically this year; Emerging Markets are down 30%
- Developed Markets x U.S. are down 20%
- U.S. Small Caps are in a bear market- down over 20% from their peak last summer and the environment for Small Cap companies according to Bank of America/Merrill Lynch is “horrible as investors have grown more risk averse and are shunning small companies.”
- KBW the NASDAQ bank index is down nearly 20%, while Citigroup and Bank of America are down almost 30%. With low interest rates and slow credit growth, banks are caught in a negative cycle.
- S&P500 earnings according to Oxford World Digest “are much worse than you ever thought. The gap between pro forma and reported earnings has reached its widest level since the Financial Crisis. If you look at earnings based on GAAP, earnings per share fell 12.7%, the sharpest decline since 2008”.
- More than 100 U.S. companies have decreased or eliminated their dividend (this is more than 2008). Additionally, companies will decrease or eliminate their dividend in the next few years due to slow growth and a need for cash.
- Commodities like oil are down 75% from former highs with Bloomberg predicting another major oil price crash ahead due to falling demand. Even with the severe downturn in oil prices, an investor could get into oil at $35/barrel and suffer an approx. 50% loss should oil fall below $20. Our readers understand a 50% loss in a portfolio or position requires a 100% return on that investment, just to get back to even.
- Junk bonds are getting hammered; the ETF JNK is down 20% from the high
- Bond yields are historically low, at least the ones that have yields that are not in negative territory. Over $7T bonds have negative yields today.
- The U.S. Fed has begun tightening with next Fed meeting mid-March
- The fire power of Central Bankers is almost exhausted
- The Bond Yield Curve is flattening- the 2yr yield is less than 100 basis points and the 10 yr. is at 1.74. Normally there is a roughly 300 basis point spread. There is no reason to believe yields will not continue to narrow. This is a major indicator of a recession on the horizon. If the Feds continue to increase short term rates and long term rates remain the same or fall further, the yield will continue to narrow.
- Monetary policy delayed the inevitable, but did not and will not eliminate a drop in the equity markets.
- The U.S. cannot expect any assistance from fiscal policy for about a year; at least until after this charade of an election has been completed.
Investors that may have forgotten how it feels to lose money will have additional opportunities to experience that lesson again if they do not employ a prudent protection piece in their portfolios. These markets are unlike any we have experienced in our lifetime- the end of an economic winter for lack of a better term. They are not for the faint of heart. There is no silver bullet when investing; risks in stock and bond investing have rarely been higher for investors that are in traditional strategies.
- Nimble, unconstrained managers have lower risk than fully invested portfolios in this environment.
MCS is nimble, and unconstrained by both asset class and market direction. We will not compromise our low risk approach, or aversion to loss of principal. That being said, our other goal is to add appreciation to our accounts through proper buying and selling of investments. We take this responsibility very seriously and expect multiple trades this year alone, due to the elimination of distortions from Central Bankers. We view the professional data bases of investment managers continuously, and have a handle on the performance of our competition. With very few exceptions, that performance is not positive. Some investors may still feel the need to ‘be invested more’ or ‘take more risk’; and are free to take higher risk with other managers. High risk increases your chance of loss. Many managers love to play with “other people’s money”. No so with us. We always invest our own cash, side-by-side with our clients, in each and every investment. Very few managers do this. When evaluating a money manager or advisor, the first question should be- How much of your liquid net worth is in your strategy and how long has it been in the strategy?” Secondly- get proof. We find investors that invest with managers that don’t ‘eat their own cooking’, perplexing at best. For the record, all of the MCS employees have all of their liquid net worth in our strategy, and have been investing in this manner for decades. Always ask yourself how you would feel if you lost 10, 20 or 50% in a year or two? Worse, what if your entire portfolio was compromised?
The market action today was primarily driven by oil, as was the action yesterday. Markets have gone nowhere all week. GDP comes out tomorrow; we expect less than a 1% print, when normal U.S. GDP is 3.4-3.7%. More color on this tomorrow.
Respectfully, if we may recommend some ‘light’ reading, Nomi Prins book, “All the Presidents Bankers: The Hidden Alliances That Drive American Power” would be a good follow up for those already familiar with the Federal Reserve. As a former insider at Goldman, Bear Stearns, Lehman and Chase, Prins knows how the ‘game’ is played. Her whistleblower book, “It Takes a Pillage: Behind the Bonuses, Bailouts and Backroom Deals from Washington to Wall Street”, also makes for good reading prior to the election. One book is not a complete education but is a good start. It has never been more important for investors to understand Central Banking, including its limitations.