Have Investors Been Too Cautious?
Looking back, it seems so, but right now the odds don't seem favorable enough to be aggressively bullish.
We are at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know at some moment the black horsemen will come shattering through the terrace doors wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time. So everybody keeps asking -- what time is it? But, none of the clocks have hands.
-- The Money Game by Adam Smith (aka Jerome Goodman)
I met Jerry Goodman (nom de plume Adam Smith) over lunch with my friend Craig Drill, eponymous captain of Craig Drill Capital and one of the better risk-adjusted money managers I know. There were other money managers there who were moaning over martinis about the good ol' days in the late-1990s when they were “up” 50% (or more) in a year. These blue blood-types manage really big bucks for many of the “White Shoe,” “Carriage Trade” families in this country. Their remuneration is directly tied to how well they perform. Obviously, they have done well. However, over the past couple of years they have been “up” only 20% to 25% and consequently are singing the blues. Now martini moaning over that kind of performance may seem a bit much; still I played the groaning game with them, albeit with a grin, and sympathetically offered to pick up the check. They got the point, but earnestly explained, “We’ve just been too cautious. We’d have been up a couple hundred percent if we had been as aggressive as we were in the 1990s.”
I forgot to mention that these gentlemen are my age or older -- and have the gray hair to prove it. Though hardly geriatric, they have begun to suffer from what seems like incurable caution. They are also worried they will become victims of the current graybeard money manager go-for-gold syndrome -- “Never trust anyone over 30 with your money!” I suspect such caution will be abandoned and they will succumb to the luring lyrics of all late-stage bull moves -- “Those who do not learn from stock market history are destined to prosper ... until ...”
Webster’s defines the word “until,” when used as a conjunction, as “up to the time that” or “up to such a time as.” In the aforementioned prose, my use of the word “until” implies -- “Those who do not learn from stock market history are destined to prosper ... until they don’t!” And let me tell you “until they don’t” is a really expensive proposition as investors learned following the go-for-gold tech syndrome of 1999. Indeed, I am reminded of the old stock market “saw” from Barron Rothschild, who when asked how he made so much money replied, “I never buy at the bottom and I always sell too soon." Importantly, while I am not advocating selling everything, I am currently advocating selling some partial positions, in select stocks that have surged, to rebalance those positions and to raise a little cash.
Clayton Williams (CWEI) would be a good example. CWEI had made a lot of money; and while I still think the shares can trade higher, the strategy of selling 20% to 30% of that position makes good portfolio sense. Ditto my firm's positions in Cenovus Energy (CVE), which is rated favorably by our Canadian affiliate Raymond James Ltd.
“Selling” -- the word alone makes most investors uneasy. They find the “B” word (buying) much more pleasant. Yet “selling” has been on my mind the past few weeks and last week I acted on that feeling by selling 20% to 30% of several investment positions. It was not because I think these stocks won’t trade higher over the longer term, because I do based on their fundamentals. But rather I sold partial positions to lock in some long-term capital gains, rebalance those positions back to the portfolio weightings that were first intended, raise some cash to take advantage of some new situations I have uncovered, and to be portfolio prudent. Moreover, the often referenced “buying stampede” that began on September 1, 2010, remains legend at now session 118 compared to the previous record of 52 sessions. As my friends at Bespoke Investment Group write:
We compared the market’s pattern since September 1 to all periods of the same length in the history of the S&P 500. We then calculated the correlation coefficient between each of the same periods and the current period and found five periods where there was a correlation coefficient greater than 0.97 (1.0 = perfect correlation). While the percentage changes in the prior periods vary, the similarities between their patterns and the current period are striking. In the charts, we highlight each of these periods along with the S&P 500’s performance over the following 12 months. As shown in the charts, in all five of the most closely correlated periods to the current one, the S&P 500 saw additional gains over the following 12 months with an average gain of 22.1%!
To be sure, I agree with the good folks at Bespoke, which is why I have repeatedly stated “cautious but not bearish.” That said, if you study Bespoke’s five charts, you find that in each case the S&P 500 (SPX), at this stage of the rally, was ready for a pause and/or a correction. Further, the S&P 500 bottomed 102 weeks ago and has since rallied 100%. There have been only two other instances when that has happened, 1934 and 1937. Following the peaks of February 1934 and March 1937, the stock market corrected.
Hence, cautious but not bearish. Not bearish because individual investor exposure to equities, according to Barron’s, “Is at a generational low of 37% of all assets.” Barron’s continues by noting, “Another possible lift to the market? Rising S&P dividends, where the 26% payout ratio is less than half the 54% historic average.” Plainly I agree, but with risk appetites at their highest level since January 2006, combined with hedge funds “long” exposure at its highest level since July 2007, I can’t help but be cautious.
Despite my caution, I can still find attractive risk/reward investments. Last Monday I discussed why Royce Value Trust (RVT) was an interesting situation. Also discussed was special situation company Stanley Furniture (STLY). This morning I offer up Williams Companies (WMB). For months Wall Street has been rife with rumors that the new CEO (Alan Armstrong) was going to split the company into two parts to increase shareholder value. Over those months I discussed these rumors with many of you. Last week those rumors were realized with an attendant rating raise from our energy analyst Darren Horowitz:
Admittedly, we are late to the party with Williams' shares up over 45% since the beginning of September. Up until this point, we had assumed the pending breakup was going to take longer to materialize versus market expectations. That being said, based on the clear plan to break up the company, and the underlying value of Williams' assets, we are upgrading Williams from a Market Perform to an Outperform and setting an initial target price of $36/share.
With the pending “split” acting as the carrot in front of the horse, I think the shares trade higher.
The call for today: Recently, if you threw a brick out of a Wall Street window, it would go up! As seen in the charts, this skyscraper stampede has not given up much ground since it began on September 1, 2010. Indeed, the DJIA has not experienced anything more than the perfunctory one- to three-session pause/correction since this stampede began, not giving anyone an easy entry point. I was pretty constructive on stocks until the beginning of this year when I wrong-footedly, like my gray-haired lunch friends, turned too cautious. Still, in this business you have to play the odds; and currently I just don’t think the odds are favorable enough to be aggressively bullish. As David Sklansky wrote in his book The Theory of Poker, “Any time you make a bet with the best of it, where the odds are in your favor, you have earned something on that bet, whether you actually win or lose the bet. By the same token, when you make a bet with the worst of it, where the odds are not in your favor, you have lost something, whether you actually win or lose the bet.” I continue to invest, and trade, accordingly.
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