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