Bloomberg reports that David Samra, the Artisan Partners fund manager who won Morningstar’s international stock manager rankings for picks during the 2008 crisis and again in 2013, sees opportunity in the current market turmoil. “We welcome these types of markets,” Samra said. He maintained that market has become “very greedy” in the past few years, which he said created a selling opportunity. Right now, he says, is time to “aggressively buy.” Samra did not specify exactly what he is buying, but offered a few general thoughts. He likes wealth management over investment banking, is “not rushing to invest in China,” and suggests it is “probably time to get bullish” on oil. As for causes, Samra suggests the central banks have been too aggressive since the financial crisis: “You always run this balance between creating social unrest and creating bubbles, and we’ve erred on the side of creating bubbles,” producing “distortion after distortion. And we keep applying more aggressively the same remedies and causing more distortion.” On investing in such times, he indicated that the turmoil is an opportunity to buy stocks at high discounts, but noted: “you need a personality that can take the emotion and noise out of the equation.”
Ed Yardeni of Yardeni Research recently told Barron’s he expects a “difficult and choopy” year, but “the U.S. will come out of this in good stead.” He observed that “the risks of global recession outside the U.S. have increased,” but noted that “it this drags the U.S. into a recession, it would be the first time it has happened.” Yardeni explained part of the recent downturn by noting that “when the dollar is up 22% . . . it is equivalent to a 100-basis-point increase in the fed funds rate” because “half of S&P 500 earnings come from overseas.” Nonetheless, he sees a number of positive signs for the U.S. economy, such as a likelihood that spending will be positive or increase at all levels of government, low oil prices will drive consumer spending, and “excluding energy, profits are still growing.” According to Yardeni, the person who wins “the White House may not matter as much as [whether] the Fed . . . backs off from raising rates,” as he anticipates it will. He has “confidence the U.S. economy will remain resilient enough to grow 2.5% this year.” In Yardeni’s view, “what’s changed is we’re back in a stock-picker’s market.” He reiterated that his firm has consistently recommended investing in U.S. rather than global equities and suggested health care stocks “across the board,” “anything related to consumer entertainment services,” social media companies, and internet retailing stocks are likely to be strong performers going forward.
Collectively, mutual fund managers have a very poor track record. But while the pros struggle mightily to beat their benchmarks, that doesn’t mean that beating the market is impossible, Validea CEO John P. Reese writes in his latest Seeking Alpha column.
“In a 1984 speech he gave at Columbia University entitled ‘The Superinvestors of Graham-and-Doddsville’, [Warren] Buffett examined the remarkable track records of a small group of investors who studied under Benjamin Graham, the man known as “The Father of Value Investing,” Reese writes. “He explained that from 1954 to 1956, there were four ‘peasant level’ employees working under Graham at the Graham-Newman Corporation (David Dodd and Jerome Newman were among the firm’s other directors). Three of those ‘peasants’ (Walter Schloss, Tom Knapp, and Buffett himself) established easily traceable track records after leaving the firm, Buffett said — and all of those track records were tremendous.” Buffett concluded that this was no coincidence, and that there must be something to Graham’s techniques.
Many other great investors were inspired by Graham’s value-focused approach, Reese notes. In recent years, however, value stocks – which over the long haul have significantly outperformed more expensive stocks – have struggled. “But these periods of underperformance are where great value investors like Graham and Buffett do the hard work that lays the groundwork for future gains,” Reese explains. “When others bail on good stocks that are having short-term dips, those focused on the long term can swoop in and pick up the bargains left behind. It’s hard to do, because in the short term your portfolio can include some very unloved, declining stocks. But, as Graham, Buffett, and other ‘superinvestors’ have shown, over the long haul value and fundamentals win out. Stay disciplined, and you tilt the odds greatly in your favor.”
Reese looks at a handful of stocks that get high marks from his Graham- or Buffett-inspired Guru Strategies. Among them: industrial firm Mettler-Toledo.
James Montier of Grantham Mayo van Otterloo’s (GMO’s) Asset Allocation team spoke with Advisor Perspectives recently about interest rates, behavioral biases, and other key factors affecting markets. He said that unlike the longest-serving Fed governor William McChesney Martin, who said the central bank’s job is to “take the punch bowl away just when the party was getting interesting,” recently the Fed governors “are more like teenagers at prom night . . . spiking the punch bowl and handing out free drinks and hoping to get lucky at the end of the night.” This, he suggested later in the interview, has helped to create “very broad-based overvaluation” that is unlike the past “bubbles in smaller areas,” such as the dot-com bubble. He likened the current overvaluation to the housing bubble, which he said “was a central banks-sponsored bubble.” The current overvaluation, he said, is “the first truly global immersion of that experience” because it involves far more than the U.S. alone. The mechanism, he maintained, is that investors are inspired to believe it is not possible to “take on too much risk because ultimately the Fed will bail them out.” This is particularly important, Montier suggested, because “people get overconfident [and] tend to overestimate return and underestimate risk,” which can be very “dangerous” because “markets are essentially very fragile constructs . . . subject to tipping-point outcomes” in which reassessment of valuation rapidly breeds fear and “the world unravels.” Nonetheless, he noted the opportunity for value investors when such reassessment occurs.
Montier also attacked the idea proffered by Larry Swedroe that markets are now more efficient and, therefore, passive portfolios will necessarily outperform active managers. He distinguished between macro and micro efficiency, reasoning that markets are not significantly more efficient in either sense than they used to be. Further, he asserted that “there is always going to be some element of active management in the market that effectively acts as a behavior driver” because “if nobody is actually looking for alpha, then there will be plenty there because everything will become inefficiently priced.” He described an ebb and flow between active management and indexing (including “closet indexers”) in which the active managers reduce alpha and, as they recede, inefficiencies crop up as passive funds gain ground, which then increases opportunities to find alpha.
Montier discussed the impact of technological revolutions, including the internet, which he said always have a “good” deflationary effect in that they lower prices and thereby benefit consumers more than producers. On the market volatility thus far in 2016, he said we are simply seeing reassessment of pricing that actually reflects “the same sort of issues that we were certainly grappling with throughout last year and certainly not anything new in the last couple of weeks.”
In a piece for Barron’s, Zachary Karabell, head of global strategy at Envestnet, argues that recent changes in equities markets should be seen as a normal correction that offers opportunities. He debunks the argument for a bear market with three points. First, he says, that current “global weakness . . . is insufficient to fuel a financial market meltdown,” noting that signs of recession are limited to a few developing countries, the IMF predicts growth, and fixed income markets seem to be stabilizing. Second, Karabell argues that “China . . . clearly is not imploding,” pointing to a 50% rise in Apple’s China sales over a year, among several other indicators. Third, he points to “valuation of stocks and interest rates,” observing that “prices do not exist in a vacuum” so “it is fairly impossible to conclude what the right price of equities should be.” Thus discrediting “the idea that there is a perfect multiple that tells us when to buy and when to sell,” Karabell suggests that low volatility in credit markets and other indicators suggest we are not facing catastrophic systemic weakness as in 2008.
In this “normal correction,” as Karabell describes it, there is significant opportunity. Likening the coming years to the 1970s, he maintains that “the goal in such times is to identify sound fundamentals and pick good price points that volatility inevitably provides.” Put more directly: “this is when you buy – carefully and deliberately.”
Wired profiles the rise of artificial intelligence (AI) in investment management. Ben Goertzel’s company, Aidyia, recently began using AI to make real trades. Another company, Sentient, has been making trades according to AI recommendations since last year, according to CEO Antoine Blondeau. AI might be seen as an evolution from the use of complex statistical computer models to inform trades, but the two are different in that quant models tend to be static and AI is designed for machine learning. Two techniques that may be built into AI illustrate the point. “Evolutionary computation,” as explained by Blondeau, involves creating digital traders and tests their performance using historical data (not actual trades) so that “Over thousands of generations, trillions and trillions of ‘beings’ compete and thrive or die . . . eventually, you get a population of smart traders you can actually deploy.” While evolutionary computation appears to be the state of the art, there is debate about whether “deep learning” algorithms may provide another valuable method of AI investing. Sentient’s chief science officer, Babak Hodjat, sees potential in such algorithms, which are perhaps best known for learning to identify images, spoken words, and the natural patterns of human speech. Goertzel of Aidyia disagrees, however, suggesting that the patterns in the market are very different than the kinds of patterns that deep learning has been useful for. He also notes that deep learning may lose any advantage it creates by becoming widespread: “if everyone is using something, its predictions will be priced into the market.” Hodjat’s response to these concerns is that evolutionary computation and deep learning may be combined: “You can evolve the weights that operate on the deep learner . . . but you can also evolve the architecture of the deep learner itself.” Author and finance manager Ben Carlson challenges the potential of AI overall: “If someone finds a trick that works, not only will other funds latch on to it but other investors will pour money in too. It’s really hard to envision a situation where it doesn’t just get arbitraged away.” Goertzel, as his concerns about deep learning suggest, is sensitive to this risk and seems determined to stay on the cutting edge for that precise reason: “Finance is a domain where you benefit not just from being smart . . . but from being smart in a different way from others.”
In his column for Barron’s, Mark Hulbert reports that his analysis shows that “the best bear market strategy may very well be to stay 100% invested in equities.” He says that looking at the data on Hulbert Financial Digest-monitored advisors suggests this approach because “each of the top-five advisors for performance since March 2000 is fully invested right now” and those who switched to cash during the 2000-02 and/or 2007-09 bear markets “failed to get back into the stock market at anywhere close to the bottoms . . . [and] therefore missed out on a good chunk of the markets’ subsequent recovery.”
First place among the top performers, Marc Johnson, editor of The Investment Reporter, explained his outlook: “Some observers are alarmed by corrections and bear markets. They see these market setbacks as disasters. Our view is different: stock market setbacks can create wonderful buying opportunities.” Similarly, second-place top performer Kelley Wright of Investment Quality Trends says: “My thought is the market is simply taking care of business it was on track to do last summer” and “there are some really good values in some really great companies.” Hulbert notes that the top performers share “a bias toward value stocks,” which “historically have lost less money during bear markets” and often pay dividends.
Looking at market timers yields the same recommendation: “a far safer bet is choosing to withstand the bear market losses in order to guarantee you’ll capture 100% of the bull market’s gains.” Less than half of market timers had lower exposure at the bottom than at the top in previous bear-to-bull transitions, suggesting they are “bearish when they should be bullish, and vice versa.” Only 6% of market timers correctly predicted the top and bottom of the 2007-09 bear market. Of those who did meet one of Hulbert’s three tests for the 2007-09 bear market, less than half also did so in the 2000-02 bear market, suggesting successes may have been more luck than skill in market timing.