My Ignorance Is No Better Than Yours.

When I want your opinion I’ll give it to you. – Samuel Goldman

We humans make a lot of mistakes. I suppose I say “we” as more a rationalization of my own actions than stating the obvious about mankind. Regardless, it’s true.

I had a rather “meh” week in the market. By “meh” I mean I under-performed to the tune of about 200 bps.  That, however, isn’t what I consider a mistake – yet. I still have a healthy chunk of alpha YTD. Alas, there’s enough year left so that could easily change.

Reviewing Strategy

I’ve been deep into reevaluating various portfolio management strategies the last two weeks. I’m predisposed to stick to my knitting with a value strategy. Some tweaks are in order.

I recently read Quantitative Value by Gray and Carlisle which does a deep dive back-testing of Graham, Buffett and Greenblatt investment criteria. It’s another academic work that bolsters the argument that value outperforms growth over the long run. In the end they showed that a modified Greenblatt Magic Formula process delivered the highest alpha over time. And it’s no little difference either.  Over a 60/40 MPT process it beats by roughly 5% annual alpha. Stick that in your compounding pipe and smoke it.

The problem for me, though, is that the age of my client base might not have the time to recover from a big draw-down. It’s a big problem. [Note: I could better exploit that model if I’d get off my fat ass and go get some younger clients.]

So that leaves me with leaning more toward Cliff Asness’ AQR model of going long value and short overpriced growth names that appear to be rolling over. As in any discipline, however, the intestinal fortitude required to practice such a process is often daunting because, as Asness says, it can be horrific at times.

And shorting stocks is a tricky game in and of itself since most of the universe (stockholders, management, employees) have an incentive to make stocks go higher. Thus, shorting is always an exercise in swimming against the natural motivation currents.

It’s been a few years since I spent real time studying Ray Dalio’s risk parity model. Given the age of my client base it might be a good solution. I recall, though, a problem for the small manager in employing the leverage needed in the fixed income allocation that Bridgewater uses to get to risk parity – especially in a low interest rate environment. I’m going to revisit it this week. Perhaps I’ll see something I didn’t see before.

Instant Classic

If you haven’t yet read Howard Marks’ latest memo, It’s Not Easy, you should. This should be required readying for everyone in the market regardless of investment style.

Opinions are like…

The never ending stream of Fed rate hike discussion seems so wrong on so many levels to me, vis a vis the marginal utility of money at the Fed Funds rate, it makes me want to scream sometimes. I’m not discounting certain effects on FX – which could be substantial – but looking at the talk of how the overnight rate affects the yield curve is mostly nonsense.

The drum beat that a rate increase will help banks is garbage unless it effects rates in the 2 – 7 part of the curve (that’s no reason to avoid banks.) There is no way to know the market reaction but my guess is that given the low inflation expectations there’s no there there.

The real effect on the curve has much more to do with Fed portfolio reinvestment than the Fed Funds rate. In that regard I have seen no evidence that the Fed has plans to let their balance sheet run off.

It doesn’t escape me that the reaction to Fed moves is really more about expectations and market psychology than it is about the efficacy of monetary policy. So in the short run I could have this very wrong. But ask yourself this, what kind of a dislocation does upward pressure on the Fed Funds rate have on the economy when the Fed has been crystal clear that policy will stay accommodative – ergo, lower for longer? Get past the initial shock and I say very little.

Of course, as I said above, we might find some players way offsides in FX leveraged carry that could cause considerable pain. I doubt that though. EM currencies have been hit hard lately. One has to ask if it’s already priced in.

But, as always, I reserve the right to be wrong.

There is another discussion that keeps popping up in my stream about the likely hood of a recession. This amuses me for a few reasons. First, only the usual suspects, who have been warning of a recession for years are making the recession argument. Secondly, the people who are arguing that no recession is on the horizon seem to outnumber the other side by about 10 to 1 (within my limited anecdotal observation.) Lastly, my 40 years of experience informs me that economic measurements are so crude and imprecise that almost no one sees recessions coming before the fact. To me  this comes under the heading of things we can’t know.

For the record I don’t see a recession coming nor do I see a major expansion. So put me in the category with with everyone else – my ignorance is no better than anyone’s.

We also hear that bear markets never happen without a recession. I have to take the position that, since recessions are rarely predicted, saying so is pretty useless information other than for use in one’s bias confirmation.

Thank you for your input

I get a lot of “help” when I mention a position I have. That is to say that the world has never lacked an abundance of critics.

Just to be clear, I do a lot of homework on the stuff I trade and sometimes (often?) I’m wrong. As I’ve said, this business is hard and it’s (at least in my opinion) harder if you run other people’s money. Advisors don’t get paid to sit in cash or, if they do, their clients are over-paying (begin the “everyone’s stupid for paying management fees” here.) We take our shots where we find them with the knowledge that we will be wrong on many of them.

I was asked what my time frame this week by someone who (I think) was trying to assuage my yammering on about my under-performance. The fact is that I don’t have one but I attempt to take long term positions.

In every investment I have a thesis based on fundamentals. Regardless of short term price movements I test that theses daily – every position every day – against news, the macro background,etc. If I determine that my thesis is bunk I sell. If I determine the thesis remains, I hold or add on down prices. When price gets to what I consider to be over-extended, I sell some or all of a position. If the fundamentals improve I’ll add at a higher price. There are rules but unless one knows my theses they’re not readily seen.

I employ options if I see a fat pitch and then usually take the profits (provided I was right) and buy the common with it. And, of course, I hedge and reposition those hedges opportunistically. My options exposure rarely gets higher than 4% of my book.

I try to hold about 35 positions at any one time – which for short term traders I assume would be hard to watch.

I’m often wrong on both the downside and upside. That’s the nature of the beast.

So, I do appreciate your input. But I appreciate it more from those who have an understanding of the context of what it’s like to run money. And you’ll notice that I don’t give advise or criticize my brothers-in-arms in the advisory business. As Howard Marks said “It’s not easy.”

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If you made it this far I’ll consider sending refund checks. As my wife says, I could talk about a nickle for an hour if I found an audience. From now on just know that I’m issuing a standing apology.

 

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