Saturday, March 29, 2014

Current investment environment

A friend asked to hep with a speech to a group of investors concerning some of the key themes for the year. I focused on somber tone after a great performance year in equities. Expectations have to be tempered. Here is an outline of my thoughts.


  1. The market assessment - too long and too calm 
    1. Not trying to give a market review or try to be an economist and make a prediction on what will go up or go down
    2. Focus on the big picture - which is most important - how do you protect your money?
    3. there are many different approaches; this is why we offer many products.
      1. being long equities is less likely to work in 2014
      2. complacency is an enemy
        1. surprises will catch investors if you do not have a plan
          1. “Everyone has a plan until they get punched in the mouth” - Mike Tyson, risk manager 
  1. The market big picture
    1. Five years since trough of recession 
      1. the average length of time in the post-WWII period from trough to peak is 58.4 months. The trough was in June 2009. 
    2. Five years in a bull market rally
      1. the average is 3.8 years 
      2. only 3 of 16 rallies since the Great Depression have lasted more than 5 years. 
    3. Five years since Fed began alternative monetary policy 
      1. three rounds of QE 
      2. forward guidance to stabilize the markets
    4. Five years of “zero” interest rates
      1. unprecedented period of “no cost” for nominal borrowing
      2. extended period of negative rates 
      3. the central bank’s desire for market to borrow
    5. The volatility in markets is extremely low
      1. VIXX volatility  low
        1. 14.5% not the lowest level but long period without strong spikes
      2. Commodity volatility low
        1. lowest since financial crisis, lowest in almost a decade
      3. Rate volatility low
        1. lowest since financial crisis
      4. FX vol low end of range
  1. The low risk environment creates complacency 
    1. Low risk environment sows the seeds of the next crisis
      1. low risk creates more risk-taking;
        1. reach for yield; leverage up to offset lower returns
        2. extra credit causes bankers to compete for loans at low rates
        3. short memory causes investors to think less risk; this time is different
      2. more risk-taking creates instability
    2. Hyman Minsky discussed this in detail
      1. when there is a shift or surprise, the extra leverage and risks taken will lead to greater loses
      2. The time when this occurs is the “Minsky Moment”; the extra leverage during stable times creates more risk when the risk profile shifts
        1. Long-term capital 1998
        2. Mortgage and housing markets 2007-08
        3. Emerging markets Mexico 1994
        4. October crash 1987
  1. You get the picture
    1. Risk are growing as the market continues down this path of successful wealth creation; see it in bond covenants, the reach for yield, return chasing.
  1. what can you do?
    1. avoid the market
      1. Opportunity cost is great when rates are near zero to hold cash
    2. buy puts 
      1. can be costly insurance while we wait; 
    3. Employ strategy diversification
      1. hold more diversifying assets
      2. have a plan when the markets change
    4. employ nimbleness 
      1. prepare for switch
    5. provide convexity 
      1. look for managers that have upside potential but downside protection 



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