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Bells Don’t Ring at Market Turning Points

Knowledge is knowing that a tomato is a fruit, wisdom is not putting it in a fruit salad.

– Miles Kington

It is often pointed out that no one rings a bell to announce the top or the bottom of a market. Despite this somewhat obvious observation, investors – both individual and professional continue to try their luck, convinced they have the good sense to move in or out of markets, as conditions fluctuate from misery to euphoria. As the famous British economist, John Maynard Keynes once said upon learning this lesson the hard way, “Markets can stay irrational longer than you can stay solvent.”

The primary responsibility of both investment managers and advisors, first and foremost is to protect client assets. This in turn often translates into protecting investors from themselves, as on average we humans are known to make emotional decisions, which at times results in a transfer of wealth from the weak to the strong. We cannot predict with any certainty where markets will go in the future, however as sophisticated investors, we should attempt to play the probabilities based on both historical data and market sentiment indicators, adjusting a portfolio’s asset mix accordingly.

Back in my day as an institutional bond and interest rate derivatives trader, I would receive a number of calls and electronic messages from marketers daily, attempting to sell investments or ideas that were “sure to make me or my employer money.” Most of these ideas were duds, usually more likely to earn the seller a profit at my expense. Anyone who has had the opportunity to sit in a high-volume trading seat likely has a finely tuned BS meter. If you don’t, you won’t last long.

Anyway, a couple of weeks ago I received a sales call from an asset manager attempting to generate interest in a product he likely did not fully understand himself. I say this because the strategy he was marketing was risk seeking rather than risk reducing, however he kept insisting otherwise. Rather than go into details about this strategy, which will likely bore many readers – just visualize a person bent over picking up nickels right in front of a steamroller. And ask yourself, is it ever worth it?

I come from the investing school which contends there is no such thing as a bad investment, only a bad price. In this light, I found an article from The Wall Street Journal dated April 7, 2017,“Are Traders Creating a Bizarre New Feedback Loop... Feedback Loop... Feedback Loop?”timely as the story was published shortly after my call with the above asset manager. The authors of the article hypothesize that the recent decline in realized and implied market volatility is likely being driven by both institutional investors strong desire to be sellers of insurance protection and bank dealers’ delta hedging needs, as a result of being on the opposite side of this trade. I know for some readers this topic may be a bit technical or of little interest, however what is most striking to me about this story is that sophisticated investors appear more than willing to take open ended risk for very little reward. Per the above article, “Selling insurance, on the other hand, has been great business — and more money managers are piling in. ‘Our philosophy is always to be short volatility,’ said Bernhard Brunner, a fund manager at Allianz Global Investors, who thinks selling options on U.S. and Eurozone stocks remains attractive.”

I tend to be risk averse in my investment dealings. After all, it is my job to think of all the things that can go wrong in pursuit of preserving and growing our clients’ wealth. However, as mentioned above, I believe investments on a stand-alone basis cannot be judged as neither good nor bad per se. It is the price paid or received that determines value or lack thereof. The future is uncertain, but we can make informed investing decisions at the proper time and price when probabilities move in our favor. Based on the chart below in Figure 1, which was sourced from the above article, investors are now purchasing protection insurance at the some of the cheapest levels over the past six years, while sellers are happily underwriting this protection and receiving very low premiums in return. News flash - this usually doesn’t end well for the sellers.

The U.S. stock market looks highly valued based on statistical metrics, while sentiment indicators also seem to be pointing in the same direction. This does not mean the market will decline tomorrow, next month, or next year but it does suggest some caution is advisable. Long- term investors should not be alarmed and should not be avoiding stocks; however, it would be prudent for investors to revisit their equity allocations if say a 20% decline in the stock market would alter one’s lifestyle or cause high levels of anxiety. The bottom line is that the market is priced high on a historical basis, while insurance against large price swings is priced historically low. Professionals looking to enhance short-term returns at this late stage in the market cycle should be very careful about taking outsized risk given the potential for disproportionate losses.


Justin Kobe, CFA Founder & Portfolio Manager


Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated.Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing in the bond marketis subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.

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