The Market May Be Ugly, but This Is Not the Beginning of a Major Decline
Plus: How to invest with the best. We take a look at a number of different investment management firms and their strategies.
Finding the best person or the best organization to invest your money is one of the most important financial decisions you’ll ever make. It’s also one of the toughest. The right manager for someone else may not be the right manager for you, nor can you reasonably expect to find many objective, or even reliable, sources to help you narrow your choices. You will be bombarded with figures, charts, and statistics that seek to sell you on each adviser’s services... the sad fact is that too often you cannot even believe what has been presented to you.
-- Claude N. Rosenberg, Jr.
I have been a “fan” of the astute Mr. Rosenberg since hearing him speak back in the 1970s. Many will remember him as the founder of the San Francisco-based money management firm that used to bear his name, Rosenberg Capital Management, before changing its moniker to RCM Capital Management. Others will remember him as the author of numerous books on financial matters, one of which was Investing With the Best, which contains the above quote and deals with the daunting task of selecting an investment manager. Given the plethora of investment managers, each with their own investment philosophy and style, picking a manager is difficult. That’s why many individuals’ selection process consists of nothing more than looking at a portfolio manager’s track record for the past few years. Our firm thinks that such a simplistic approach is a mistake.
Apparently, Jeremy Grantham, eponymous captain of the money management firm Grantham, Mayo, Van Otterloo & Co., agrees. To reprise some of his thoughts: “Ninety percent of what passes for brilliance, or incompetence, in investing is the ebb and flow of investment style (i.e., growth, value, foreign vs. domestic, etc.). Since opportunities by style regress, past performance tends to be negatively correlated with future relative performance. Therefore, managers are often harder to pick than stocks. Clients have to choose between fact (past performance) and the conflicting marketing claims of various managers. As sensible businessmen, clients usually feel they have to go with the past facts. They therefore rotate into previously strong styles, which regress [to the mean], dooming most active clients to failure.”
This is where Raymond James’ Asset Management Services (or AMS), as well as our Mutual Fund Research Department, can help. As unbiased intermediaries, these departments are committed to aiding clients in the hiring of an investment manager who most closely aligns the manager/mutual fund with the client’s views on the various markets, as well as their risk tolerance. To this point, I journeyed to the cooler climes of Boston last week to escape the Florida heat, speak at a national conference, and visit with over 20 portfolio managers (or PMs). My first visit was with the folks at Pioneer Funds where I met with Marco Pirondini (Head of Equities) and his team, as well as Ken Taubes (Chief Investment Officer). I have spoken with Ken a number of times and find his wisdom both on stocks and bonds to be invaluable. Because of his long tenure as a bond manager, I was surprised when he opined that interest rates should bottom between now and year end. Given that “higher interest rate” view, I was particularly interested in speaking with Jonathan Sharkey who manages the Pioneer Floating Rate Fund (FLARX) and the Multi-Asset Ultrashort Income Fund (MAFRX). In a rising rate environment these two funds should fair pretty well. I discussed Jon’s investment style/strategy over dinner and found it to be closely aligned with mine. I was also interested in the Pioneer Research Fund (PATMX) and will be vetting it, along with other Pioneer funds, over the coming months.
After a few more meetings with hedge funds that afternoon, I spent most of Wednesday with Fidelity. My first meeting was with Jurrien Timmer, co-portfolio manager along with Andrew Dierdorf, of the Fidelity Global Strategies Fund (FDYSX). To me, FDYSX is tantamount to a global macro fund because it can “go anywhere” and “do anything.” That means it can invest in just about everything. Moreover, I like the fact that the fund has a technical analysis overlay to it, as well as a tactical leaning, since tactical is what has been working in this manic-depressive market. Next was Charles Myers, captain of the Fidelity Small Cap Value Fund (FCPVX). Chuck told me that while he is really good at picking stocks, he is less confident with his market timing and sector selection abilities. Accordingly, he spends his days looking for good companies and thinking about portfolio construction. Indeed, he adds value to the investment equation through portfolio construction. He does run a concentrated portfolio (~70 names) and does adjust his turnover rate to take advantage of when the markets are more dynamic.
Fidelity Select Health Care Fund (FSPHX) is managed by Edward Yoon and has provided very good risk adjusted returns over time. My meeting with him was informative as he thinks insurance companies and PBMs are part of the health care solution. Strategically, Eddie thinks the health care system has never let customers know what things cost, but that’s changing because employers are moving health care risks from their balance sheets to the employee’s balance sheet. This should be a boom for companies that provide consumers with the ability to analyze price competition between vendors. He also suggested that there is going to be a shift from public to privatized Medicare. A couple of names he mentioned covered by our fundamental analysts were: Cerner (CERN) and Nuance (NUAN). My last meeting was with Steve Wymer, who told me the S&P 500 investment style is too conservative for a growth fund and the Nasdaq Composite Index is too aggressive, so he runs The Fidelity Advisor Growth Opportunity Fund (FAGOX) somewhere in between. He thinks we are somewhere in the mid-cycle of a recovery provided the euroquake doesn’t derail us. Dinner Wednesday was with the good folks from Fidelity.
The next morning, I arrived at MFS, which is an active global asset manager that employs a uniquely collaborative approach to build better insights for our clients. Their investment approach has three core elements: Integrated research, global collaboration, and active risk management. Of course, “risk management” is a big thing with me since the essence of portfolio management is the management of risk, not the management of returns. My meeting was with Jim Swanson (Chief Investment Strategist) and eight PMs/analysts. Jim began by stating that people he meets in everyday life talk about how bad the stock market is. He then “closed” that comment by noting the S&P 500 (^GSPC) is up nearly 12% YTD, while the Nasdaq Composite (^IXIC) is better by ~16%. Moreover, when you impact those returns for the almost non-existent inflation, the “real” returns are awesome. The rest of the conversation was about the topics du jour (government, euroquake, the fiscal cliff, etc.). Regrettably, I did not have the time to meet with my friend Thomas Melendez, who manages my favorite international fund, MFS International Diversified Fund (MDIDX), or the PM of the MFS New Discovery Fund (MNDAX), but that will happen during my next trip.
My final meeting was with Putnam to reconnect with Bill Kohli, portfolio manager of the Putnam Diversified Income Trust (PDINX) that has so often been featured in these comments. It is one of only two bond funds I have featured over the years because I think PDINX is positioned for a higher interest rate environment. The fund has a 5.8% yield with zero duration. The fund employs 70 to 80 different strategies to pursue a diverse range of opportunities. For example, the fund is “long” non-agency RBMS (Residential Mortgage Backed Securities), but hedges that position with agency IOs (Interest Only). Hence, to lose money on those positions would require home prices to collapse over 50% from their already depressed prices. And then there was David Glancy and his Putnam Equity Spectrum Fund (PYSAX). Hereto David thinks a lot about portfolio construction and combines stocks, bonds, bank loans, convertibles, opportunistic short-selling, and cash to produce returns. To this cash point, I was taught early in this business that cash is indeed an asset class for to assume the investment “opportunity sets” that are available today are as good as those presented next week, next month or next quarter is naive; and you need to have some cash to take advantage of those opportunities. Evidently David thinks that as well because his cash position has varied from 44.4% in 2Q09 to 14.8% in 3Q10. David loves stocks and I could talk individual companies with him for hours. As always, all of these mutual funds should be vetted before purchase.
As for the stock market, not much really happened in my absence as the Dow Jones Industrials (INDU) experienced their tightest weekly trading range since January 2007. Of course, that was not the case a year ago when our sovereign debt was downgraded and equities collapsed 6.66% (the mark of the devil as well as the intraday low of March 6, 2009 where the new bull market began). Indeed, what a difference a year makes. Nevertheless, the rotation away from the defensive sectors and into materials (+2.83%), energy (+2.34%), and technology (+2.10%) is an interesting observation because when the defensive sectors lead it is not indicative of a healthy and sustainable rally. Said rotation reinforces my belief that the upside breakout above the 1360 – 1366 level is for real and suggests we are finally setting up for another push to the upside. The real battle should be waged at the April highs of 1422. That said, the rally that began on June 4 has left all of the macro sectors overbought in the short term. It has also left the SPX at the top of the parallel chart channel (read: resistance) referenced in last Monday’s letter. Consequently, a pause or pullback attempt is not out of the question. Support remains in that 1360 – 1366 zone for the SPX.
The call for this week: The good: Stocks are hanging in pretty well after an 11% rally from the June 4 low, earnings are still beating estimates by ~60%, earnings revisions are rising again, economic reports are strengthening, European equities have rallied while their sovereign yields have declined, the SPX continues to track the typical election pattern (see the below chart from the sagacious Bespoke organization), and there was a rare “buy signal” from the Bob Farrell sentiment indicator. The bad: All sectors are overbought, companies are beating revenues estimates by only 48.3%, the number of new highs is shrinking, upside momentum has waned, we are at the top of a parallel channel in the SPX chart. The ugly: Forward earnings guidance is negative by 5.5%, the presidential election rhetoric is getting nastier, commercial hedgers have moved close to their most extreme short position in years, the Volatility index (^VIX) is below 15 (read: no fear), gasoline had its largest two-week rise this year (+$0.18), and the list extends. Nevertheless, I think this is the pause that refreshes and not the start of a big decline.