One of the smartest guys in the room is David Swensen who runs the Yale endowment and wrote a brilliant book on portfolio management some time ago. The greatest mistake I've made in this past year has been to not heed one of his dictums, or worse half of one of them.
"Bonds exhibit the most extreme misalignment of interests, as most debt issuers benefit by reducing the value of debt obligations, resulting in direct conflict between the goals of borrowers and lenders....
...Investors frequently own more fixed income than necessary to protect against hostile financial environments, leading to behaviour that undermines the fundamental purpose of holding bonds. Confronted with a larger than ideal allocation to fixed income, investment managers often seek to enhance returns by accepting credit, option, and currency risk. Although under normal circumstances, risky bonds might generate superior returns, investors face likely disappointment in times of financial stress."
Mr. Swenson pretty well nailed it in his book published in 2000. I knew that reaching for yield could end in tears and I chose to put clients into a bond fund that has long been among the best multi sector bond investors. I trusted the value of the management of the fixed income portion of porfolios at a time when market stress erupted. The credit debacle decimated the value of the Loomis Bond Fund as every variety of bond other then US Treasury issues plummeted.
The value of struggling to gain the incremental gains in yield in fixed income has been a lesson to many. There are no free lunches.
John Barnyak
President
Stonehouse Asset Management
Wednesday, December 10, 2008
Better in the Mattress!
Yesterday the world gave a collective vote to its view of the economy. Blah! The United States Treasury had its regular auction to borrow money. We've got lots to pay for and feed the recent largesse so borrow we must. Could it have gone better?!!? We should all be so lucky.
The Three Month T-Bill went to a negative yield. "Investors" actually paid the U.S. Government to take their money. That -0.005% yield is the the lowest since the auctions began in 1929. They actually paid more than they will get back!
It doesn't get more cautious than handing over money JUST to get it back.
If you believe that the massive global fiscal stimulus and monetary easing will fail and deflation will prevail, such such caution is warranted. It won't and irrationality is the place where long term thinking is best used.
Think ahead.
John Barnyak
President
The Three Month T-Bill went to a negative yield. "Investors" actually paid the U.S. Government to take their money. That -0.005% yield is the the lowest since the auctions began in 1929. They actually paid more than they will get back!
It doesn't get more cautious than handing over money JUST to get it back.
If you believe that the massive global fiscal stimulus and monetary easing will fail and deflation will prevail, such such caution is warranted. It won't and irrationality is the place where long term thinking is best used.
Think ahead.
John Barnyak
President
Don't Blink
As of yesterday, we are in a bull market! Before you start throwing shoes, plates anything not nailed down, consider the definition of a bull market. A twenty percent rise, preceded by a twenty percent decline is by definition a bull market. All hail the bull. Over the past 408 trading days, this is the first moment when equity markets have risen twenty percent or more. From 10/9/2007 until 11/20/2008 we have been in a bear market. Yes it IS all a bit of bull but an instructive one nonetheless.
Consider what the market is telling us. Some of the relentless downward pressure seems to have abated. Either long term buyers are beginning to emerge or short traders are beginning to cover their positions and beginning to go to neutral if not bullish postures. Do not be certain that we have passed the bottom of this market though.
During the popping of the dot com bubble, there was a thirty percent rally ending a six month bear market on 9/21/2001. Over the next year, that thirty percent rally was followed by another thirty percent loss to a lower low; which was followed by another twenty percent gain, followed by another twenty percent retracement…..followed by yet another twenty-six percent upswing……and another eighteen percent drop. All of this was within the period from 3/3/2002 to 3/9/2003, twelve months of gut wrenching volatility. Each move would have been a full year’s result in a trending market.
But the process of bottoming is not a trending market. Market bottoms do not occur with an all-clear siren wailing. Rather they emerge, after months or even years of testing and retesting. Unfortunately such volatile swings are the domain of nimble traders, not investors. But the time to panic is past and the time to strategize is now. Investors should be returning to long term strategic allocations. Add to equities slowly aware that the end of this terrible market will be a process, not an event.
John Barnyak
President
Consider what the market is telling us. Some of the relentless downward pressure seems to have abated. Either long term buyers are beginning to emerge or short traders are beginning to cover their positions and beginning to go to neutral if not bullish postures. Do not be certain that we have passed the bottom of this market though.
During the popping of the dot com bubble, there was a thirty percent rally ending a six month bear market on 9/21/2001. Over the next year, that thirty percent rally was followed by another thirty percent loss to a lower low; which was followed by another twenty percent gain, followed by another twenty percent retracement…..followed by yet another twenty-six percent upswing……and another eighteen percent drop. All of this was within the period from 3/3/2002 to 3/9/2003, twelve months of gut wrenching volatility. Each move would have been a full year’s result in a trending market.
But the process of bottoming is not a trending market. Market bottoms do not occur with an all-clear siren wailing. Rather they emerge, after months or even years of testing and retesting. Unfortunately such volatile swings are the domain of nimble traders, not investors. But the time to panic is past and the time to strategize is now. Investors should be returning to long term strategic allocations. Add to equities slowly aware that the end of this terrible market will be a process, not an event.
John Barnyak
President
Wednesday, November 26, 2008
Please Sir, May I Have Some More??
Much like Oliver Twist with outstretched hands holding his bowl, if there is gruel to be ladled out, there seems there are those asking for more. Give the mouse a cookie and he will ask for milk.
Clearly, in this extreme (although not unprecidented) moment in our economic history policy makers will be listening to dozens if not hundreds of requests for financial gruel. For some, the risks may be worth the reward, for others, they should be shown the door.
One such lobbying effort is coming from the Homebuilders Association. These shameless characters (lobbyists are not paid to have shame) are suggesting that in a market with an oversupply of unsold housing inventory, they should be building *more*, not less. They are asking that the U.S. taxpayer subsidize the building of unneeding housing stock in order to ....in order to what? People who cannot save enough to put a downpayment on a house need a $22,000 tax credit to do so? For those cannot afford the monthly payments, let the taxpayer subsidize interest rates for comforming mortgages lowering rates from 6% to 3%.
Sounds like a perfect hangover rememdy recommended to me once by a Russian alcoholic, drink more and more vodka. Any legislator who lets these lobbyists even buy them a lunch should be flogged.
John Barnyak
President
Clearly, in this extreme (although not unprecidented) moment in our economic history policy makers will be listening to dozens if not hundreds of requests for financial gruel. For some, the risks may be worth the reward, for others, they should be shown the door.
One such lobbying effort is coming from the Homebuilders Association. These shameless characters (lobbyists are not paid to have shame) are suggesting that in a market with an oversupply of unsold housing inventory, they should be building *more*, not less. They are asking that the U.S. taxpayer subsidize the building of unneeding housing stock in order to ....in order to what? People who cannot save enough to put a downpayment on a house need a $22,000 tax credit to do so? For those cannot afford the monthly payments, let the taxpayer subsidize interest rates for comforming mortgages lowering rates from 6% to 3%.
Sounds like a perfect hangover rememdy recommended to me once by a Russian alcoholic, drink more and more vodka. Any legislator who lets these lobbyists even buy them a lunch should be flogged.
John Barnyak
President
Tuesday, November 25, 2008
Perspective II
Each day we are fed yet another incomprehensible number
If we add in the Citi bailout, the total cost now exceeds $4.6165 trillion dollars. The current Credit Crisis bailout is now the largest outlay In American history.
Jim Bianco of Bianco Research crunched the inflation adjusted numbers. The bailout has cost more than all of these big budget government expenditures – combined:
• Marshall Plan: Cost: $12.7 billion, Inflation Adjusted Cost: $115.3 billion
• Louisiana Purchase: Cost: $15 million, Inflation Adjusted Cost: $217 billion
• Race to the Moon: Cost: $36.4 billion, Inflation Adjusted Cost: $237 billion
• S&L Crisis: Cost: $153 billion, Inflation Adjusted Cost: $256 billion
• Korean War: Cost: $54 billion, Inflation Adjusted Cost: $454 billion
• The New Deal: Cost: $32 billion (Est), Inflation Adjusted Cost: $500 billion (Est)
• Invasion of Iraq: Cost: $551b, Inflation Adjusted Cost: $597 billion
• Vietnam War: Cost: $111 billion, Inflation Adjusted Cost: $698 billion
• NASA: Cost: $416.7 billion, Inflation Adjusted Cost: $851.2 billion
TOTAL: $3.92 trillion
______________________________________________________________________
data courtesy of Bianco Research
That is $686 billion less than the cost of the credit crisis thus far.
The only single American event in history that even comes close to matching the cost of the credit crisis is World War II: Original Cost: $288 billion, Inflation Adjusted Cost: $3.6 trillion.
The credit bubbles created by public policy blunders have created the greatest economic "do-over" in history. Now we must be watchful of the law of unintended consequence as officials try desperately to right the boat. Hopefully without creating the next crisis.
John Barnyak
President
If we add in the Citi bailout, the total cost now exceeds $4.6165 trillion dollars. The current Credit Crisis bailout is now the largest outlay In American history.
Jim Bianco of Bianco Research crunched the inflation adjusted numbers. The bailout has cost more than all of these big budget government expenditures – combined:
• Marshall Plan: Cost: $12.7 billion, Inflation Adjusted Cost: $115.3 billion
• Louisiana Purchase: Cost: $15 million, Inflation Adjusted Cost: $217 billion
• Race to the Moon: Cost: $36.4 billion, Inflation Adjusted Cost: $237 billion
• S&L Crisis: Cost: $153 billion, Inflation Adjusted Cost: $256 billion
• Korean War: Cost: $54 billion, Inflation Adjusted Cost: $454 billion
• The New Deal: Cost: $32 billion (Est), Inflation Adjusted Cost: $500 billion (Est)
• Invasion of Iraq: Cost: $551b, Inflation Adjusted Cost: $597 billion
• Vietnam War: Cost: $111 billion, Inflation Adjusted Cost: $698 billion
• NASA: Cost: $416.7 billion, Inflation Adjusted Cost: $851.2 billion
TOTAL: $3.92 trillion
______________________________________________________________________
data courtesy of Bianco Research
That is $686 billion less than the cost of the credit crisis thus far.
The only single American event in history that even comes close to matching the cost of the credit crisis is World War II: Original Cost: $288 billion, Inflation Adjusted Cost: $3.6 trillion.
The credit bubbles created by public policy blunders have created the greatest economic "do-over" in history. Now we must be watchful of the law of unintended consequence as officials try desperately to right the boat. Hopefully without creating the next crisis.
John Barnyak
President
Perspective I
When in the middle of a maelstrom it is hard to catch a glimpse of where one is as the world spins past. The next few entries will try to give some perspective on a few items economic and investment in orientation.
Harvard University is renowned for having the largest endowment in existence. It provides the fuel that keeps the university the envy of the world and the font of great thinking and research by the top minds of the globe. In 1974, Harvard's endowment suffered its worst setback as it saw a 12% decline in the endowment in a very difficult economy and market. The Oil Shock was in full swing and the world saw a global recession of significant proportion.
In 1984, 2001 and 2002 the investments held by Harvard's endowment had "hiccups" as the President termed by with slight negative returns.
In 2008 the Harvard Endowment is projected to decline by 30%.
Nobody is getting out unscathed.
John Barnyak
President
Harvard University is renowned for having the largest endowment in existence. It provides the fuel that keeps the university the envy of the world and the font of great thinking and research by the top minds of the globe. In 1974, Harvard's endowment suffered its worst setback as it saw a 12% decline in the endowment in a very difficult economy and market. The Oil Shock was in full swing and the world saw a global recession of significant proportion.
In 1984, 2001 and 2002 the investments held by Harvard's endowment had "hiccups" as the President termed by with slight negative returns.
In 2008 the Harvard Endowment is projected to decline by 30%.
Nobody is getting out unscathed.
John Barnyak
President
Wednesday, November 19, 2008
Been There Done That
Over the past month as the market roiled and the economy slipped more decisively into recession I have listened as many have used words like, "unprecedented" and "uncharted waters." In fact it is neither. In the last decade investors have been assaulted with pronouncements of how this time it is different and how productivity and technology and countless other items have made history irrelevant. Now that the same people are trotting out the other side of the proverbial cliche' coinage it is time to consider the sources.
We have all from time to time been beguiled by a story which keeps making our own seem out of sync. We only have so much intestinal fortitude when our own theses are being assaulted by daily contradiction.
It is important at a time like this to consider what equity prices are. With so many publications and programs creating a roll the dice mentality, it is easy to forget, or even never consider, what the price of a share represents. It is the claim on a very long term cash flow of the underlying entity. Implicit is the riskless alternative investment, U.S. Government bonds, the expectation of inflation and the risk premium of the equity investment.
Each of these is of course too dynamic to pluck from the headlines as the basis of a long term investment strategy. For a long term strategy long term perspective is needed.
As emotion as well as a dismal reality take hold, it is worth stepping back to the true concept of equity ownership. There is a series of issues worth considering:
1. Equity ownership is the acceptance of risk for the prospect of greater return than in a risk free investment. Currently that risk is the lowest in decades.
2. In the present environment to consider any specific company secure from the real pressures of economic realities is a greater leap of faith than we have seen in many years. General Motors and Merrill Lynch have given a serious dose of harsh reality that is possible.
3. The capitalistic model of commerce and economic growth will endure as it has since the first souk where mercenaries traded plundered wealth for camels.
4. The first order importance is return *of* capital rather than return *on* capital.
5. We should normalize earnings to smooth out the noise of quarterly earning of the market since the focus on momentary earnings will provide a target moving too quickly to be useful. Since market earnings must track closely GDP I use GDP for historical perspective.
1790 to 2007 GDP growth was 5.30 annualized
1885 to 2007 GDP growth 5.98% Dow Industrial Average 5.01%
1932 to 2007 GDP growth 7.55% DJIA 7.38%
1949 to 2007 GDP growth 7.04 DJIA 7.69%
1991 to 2007 GDP growth 5.75 DJIA 9.85%
2003 to 2008 est GDP growth 5.11% DJIA -9.63%
As one can see GDP growth is a relatively steady event. Market performance over time tracks slightly above or below economy performance. In the multibubble era since the early 1990's the stock market delinked from the economy; a logical impossibility in the long run. Now again it has delinked although this time with the market lagging as it has quickly unwound decade long excess.
The credit bubble which began decades ago will not be dismissed easily or quickly. Having said that, the fall in the equity market in the past year have brought the valuation based on normal growth of the economy over the long term more reasonable than seen in many years.
The market action is terrible. Calling the bottom of the market is impossible. However buying a call on the future earnings of the economy at a low price makes far more sense than paying an excessively high price. We will be legging clients back in slowly over the next months and year.
John Barnyak
President
We have all from time to time been beguiled by a story which keeps making our own seem out of sync. We only have so much intestinal fortitude when our own theses are being assaulted by daily contradiction.
It is important at a time like this to consider what equity prices are. With so many publications and programs creating a roll the dice mentality, it is easy to forget, or even never consider, what the price of a share represents. It is the claim on a very long term cash flow of the underlying entity. Implicit is the riskless alternative investment, U.S. Government bonds, the expectation of inflation and the risk premium of the equity investment.
Each of these is of course too dynamic to pluck from the headlines as the basis of a long term investment strategy. For a long term strategy long term perspective is needed.
As emotion as well as a dismal reality take hold, it is worth stepping back to the true concept of equity ownership. There is a series of issues worth considering:
1. Equity ownership is the acceptance of risk for the prospect of greater return than in a risk free investment. Currently that risk is the lowest in decades.
2. In the present environment to consider any specific company secure from the real pressures of economic realities is a greater leap of faith than we have seen in many years. General Motors and Merrill Lynch have given a serious dose of harsh reality that is possible.
3. The capitalistic model of commerce and economic growth will endure as it has since the first souk where mercenaries traded plundered wealth for camels.
4. The first order importance is return *of* capital rather than return *on* capital.
5. We should normalize earnings to smooth out the noise of quarterly earning of the market since the focus on momentary earnings will provide a target moving too quickly to be useful. Since market earnings must track closely GDP I use GDP for historical perspective.
1790 to 2007 GDP growth was 5.30 annualized
1885 to 2007 GDP growth 5.98% Dow Industrial Average 5.01%
1932 to 2007 GDP growth 7.55% DJIA 7.38%
1949 to 2007 GDP growth 7.04 DJIA 7.69%
1991 to 2007 GDP growth 5.75 DJIA 9.85%
2003 to 2008 est GDP growth 5.11% DJIA -9.63%
As one can see GDP growth is a relatively steady event. Market performance over time tracks slightly above or below economy performance. In the multibubble era since the early 1990's the stock market delinked from the economy; a logical impossibility in the long run. Now again it has delinked although this time with the market lagging as it has quickly unwound decade long excess.
The credit bubble which began decades ago will not be dismissed easily or quickly. Having said that, the fall in the equity market in the past year have brought the valuation based on normal growth of the economy over the long term more reasonable than seen in many years.
The market action is terrible. Calling the bottom of the market is impossible. However buying a call on the future earnings of the economy at a low price makes far more sense than paying an excessively high price. We will be legging clients back in slowly over the next months and year.
John Barnyak
President
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