“Common sense is not so common.” – Voltaire
Life as an independent investment manager can be quite lonely at times. For better or worse, the days of working in a large corporate office populated with people, personalities and perks now seem so distant to me. Gone are the routine office politics, after-work drinks or periodic free lunches. Instead, my day is filled navigating piles of paperwork and taking care of clients while thinking about the financial markets. Work is just that – work – as I’d be foolish to squander away the precious time needed to grow my practice on non- productive endeavors. At the end of the day there is but one person responsible if things do not work out and there is no hiding from this fact.
The way I see it, the main benefit of going independent, is well err, the independence. I do not have a boss or layers of bosses telling me what to do, how to do it, or when to do it. If I want to spend hours upon hours reading periodicals and researching ideas, I can do this guilt free. This is a good thing of course, as a large part of being an investment manager or advisor has to do with the ability to read and absorb anything and everything out there. There are no quotas to be met or products to sell. My objective is to make my clients the most amount of money for any given level of risk. I do this by sifting through the noise, making sense of complexities and then drawing on judgment given incomplete and/or imperfect information.
The crowd is usually wrong. If most people are on the same page then the value of any asset, or lack thereof has likely been arbitraged away, and the best one can hope for on average are market returns. There is only one way to achieve excess returns and that is by doing what others are not. With that said, market prices have a way of overshooting to both the upside and downside and it is difficult to determine how long any given mispricing will stick around. There is a long list of investors and traders who have been wiped out in the short term to only be proven correct later on. But who cares about being right? The name of the game is to produce returns and make money.
If I had a dime for every time a mutual fund salesperson told me that U.S. Treasuries were rich and that no one gets the macro trend on interest rates correct, I’d have a heavy pocket overflowing with coins. Over my past career as an interest rate trader, I worked with many top-notch strategists, traders and sales people who recognized early on the structural and economic changes going through the developed world and how that could translate into lower equilibrium interest rates and respective Fed policy. For those investment managers and advisors, who appear at least to me, more focused on being right over making money, please defend your bond under- allocation given the ongoing thirty plus year bull market (Figure 1). At what point would you be willing to throw in the towel and admit that you don’t get it? I know - this time is different.
Vikram Rai, who is an interest rate strategist at Citigroup recently produced a report that was partially circulated over the investment website ZeroHedge.com. Mr. Rai is supportive of U.S. Treasury bonds, and notes that U.S. Treasuries account for almost 60% of all global positive yielding G10 debt (Figure 2). According to Mr. Rai there is about $39 TR of outstanding G10 debt while negative yielding debt has jumped to $13.7 TR and now accounts for 35% of all G10 debt (Figure 3). He concludes, “given that USD denominated debt is still extremely attractive vs. most high-grade sovereign
debt, we expect a structural increase in demand from foreign investors that are seeking refuge from a negative rate environment.” I agree.
When analyzing investments, it is important to look at valuations relative to other investment options. I believe the mistake many investors make is that they look at current valuations on a stand-alone basis and simply compare where they are now to where they have been historically. The Shiller P/Eratio, also know as the CAPE (Cyclically Adjusted Price Earnings Ratio) is a popular method professional investors use to determine the value of stocks. Based on the CAPE Price/Earnings ratio, U.S. stocks appear expensive as they lay more than one standard deviation above their historic mean (Figure 4).
However, I find that analyzing the stock market, without taking into consideration current levels of long-term interest rates, where they may be going in the future, and how long they could remain there akin to ignoring the other useful tools available in one’s toolbox. Not only must the investor take into account the expected returns of competing asset classes to determine relative value, but in the case of stocks one must consider the current interest rate appropriate to mathematically discount future earnings and what that could mean for today’s present valuations.
With this in mind, I can make the case for U.S. stocks going higher over the coming (Figure 4)
months, quarters, or even years as historically low interest rates could support higher Price/Earnings multiples. Sure stocks look expensive based on the time series data everyone crunches, but shouldn’t investors take into account that the past data does not include a regime of prolonged low, zero, or even negative global interest rates?
Based on this logic, I believe many asset classes have potential to move higher from here despite stretched valuations. Volatility could also remain elevated, possibly magnifying the difference in future outcomes for investors. In my opinion, investors who utilize high quality investment managers/wealth managers in this complex environment will likely be rewarded.
Lastly, I would like to highlight a recent memo written by Howard Marks, Co-Founder and Co-Chairman of the asset management firm Oaktree Capital Management. In his latest piece “Economic Reality,” he hits the nail on the head where he tackles economic philosophy and current election politics, using a common sense approach. Warning - he is highly critical of populism - both rightwing and leftwing politics including presidential candidates Donald Trump and Bernie Sanders. Politics aside, I find his thought process to be a clarifying force on the issues, in what otherwise can be messy, emotional, and confusing for many of us. The memo is on the long side but is well worth the read.
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.