Lost in the “noise” of the year-end soothsaying contests are some simple lessons on investing.
The following is the investment commentary of Jeffrey Saut, chief market strategist for Raymond James, for the week of December 27:
Lost in the “noise” of the year-end soothsaying contests are some simple lessons on investing. One of the best examples of these lessons was published in The Financial Analysts Journal in 1995. It was penned by Arthur Ziekel (at the time head of Merrill Lynch Asset Management) as a letter to his daughter on investing. To wit: “Personal portfolio management is not a competitive sport. It is, instead, an important individualized effort to achieve some predetermined financial goal balancing one’s risk-tolerance level with the desire to enhance capital wealth. Good investment management practices are complex and time consuming, requiring discipline, patience, and consistency of application. Too many investors fail to follow some simple, time-tested tenets that improve the odds of achieving success and, at the same time, reduce the anxiety naturally associated with an uncertain undertaking. I hope the following advice will help:
A fool and his money are soon parted.
Investment capital becomes a perishable commodity if not handled properly. Be serious. Pay attention to your financial affairs. Take an active, intensive interest. If you don’t, why should anyone else?
There is no free lunch.
Risk and return are interrelated. Set reasonable objectives using history as a guide. All returns relate to inflation.
Better to be safe than sorry.
Never up, never in. Most investors underestimate the stress of a high-risk portfolio on
the way down.
Don’t put all your eggs in one basket.
Diversify.
Asset allocation determines the rate of return. Stocks beat bonds over time. Never overreach for yield.
Remember, leverage works both ways. More money has been lost searching for yield than at the point of a gun.
Spend interest, never principal.
If at all possible, take out less than comes in. Then, a portfolio grows in value and lasts forever. The other way around, it can be diminished quite rapidly.
You cannot eat relative performance.
Measure results on a total return, portfolio basis against your own objectives, not someone else’s.
Don’t be afraid to take a loss.
Mistakes are part of the game. The cost price of a security is a matter of historical significance, of interest only to the IRS. Averaging down, which is different from dollar cost averaging, means the first decision was a mistake. It is a technique used to avoid admitting a mistake or to recover a loss against the odds. When in doubt, get out. The first loss is not the best but is also usually the smallest.
Watch out for fads.
Hula hoops and bowling alleys (among others) didn’t last. There are no permanent shortages (or oversupply). Every trend creates its own countervailing force. Expect the unexpected.
Act.
Make decisions. No amount of information can remove all uncertainty. Have confidence in your moves. Better to be approximately right than precisely wrong.
Take the long view.
Don’t panic under short-term transitory developments. Stick to your plan. Prevent emotion from overtaking reason. Market timing generally doesn’t work. Recognize the rhythm of events.
Remember the value of common sense.
No system works all of the time. History is a guide, not a template.
This is all you really need to know . . . Love Dad”
Lessons, I’ve learned a few over my 40 years in this business. Two of the more important ones sprung from the lips of Warren Buffet – lesson number one, “Don’t lose money;” lesson number two, “Don’t forget lesson number one.” Or as my father says, “If you manage the downside the upside will take care of itself.” Another lesson I’ve learned is not to participate in the annual charade of predicting where the stock market will be at this time next year. While I know it makes for good media fodder, you will do just as well by flipping a “lucky penny.” Indeed, making predictions, especially about the future, is difficult. For example, hanging on my office wall is a reprint from the December 2007 edition of Barron’s where Wall Street strategists made forecasts about where the stock market would be in December 2008. Their bullish guesstimates, flying in the face of the November 20, 2007 Dow Theory “sell signal,” were so wrong I won’t even scribe them.
To be sure, it is far easier to make an S&P 500 earnings estimate for the coming year than it is to predict what price earnings multiple a manic depressive Mr. Market is willing to put on that estimate. Accordingly,
when asked where stocks will be in December 2011 my response has been, “Barring a geopolitical event, and if the politicians stay out of the way and don’t make a policy mistake, I think stocks will be higher.” That constructive view is driven by what I think will be an improving economy with a concurrent marginal increase in employment. As for interest rates, they should be higher, but higher for the right reasons (an improving economy). If correct, that also means the U.S. dollar is unlikely to collapse. Yet another lesson I’ve learned is to consider investing in unloved, and consequently under owned, asset classes. One of my better
“unloved” insights was to buy stuff-stocks (energy, metals, timber, agriculture, water, cement, etc.) in late 2001 when China joined the World Trade Organization, ushering in a rise in Chinese incomes.
History shows that when per capita incomes rise people consume more stuff. Continuing with that “unloved” theme, I have recently begun to look at bank stocks after avoiding them for roughly 10 years. While banks are not totally unloved, they are most certainly under owned. If 2011 turns out to be “The year of
the banks,” the financials may have the wind at their back. While I continue to eschew most of the money center banks, certain banks that are not under the government’s aegis have been increasing their dividends. To me that is a sign they are comfortable with their capital ratios.
Two names I have mentioned in past missives are IBERIABANK Corporation (IBKC/$60.36/Strong Buy) and
People’s United Financial (PBCT/$13.92/Strong Buy). Surprisingly, my more favorable view of select banks has sparked another question, “Are you also warming to the homebuilders?” Here’s the response.
“I’ve been getting a lot of calls lately after I was busy pointing out the jump in lumber prices as a leading indicator people like to use for trading the homebuilding stocks (builders). Over the past couple of years, lumber futures have worked as a great leading indicator for potential demand shifts in the builders, particularly around the time of the tax credit expiration. However, lumber futures are not perfectly correlated with actual home sales. They are subject to not only U.S. housing demand, but either external supply shocks from Canada or changing patterns of international demand soaking up exports. I’ve talked with the Canadian timber team, and it appears the jump in lumber is likely a result of the latter. Specifically a surge in export demand from Chinese construction pulling lumber supplies out of the Pacific NW ports. They specifically point to an unusual price inflection between Western spruce pine fir (WSPF) relative
to Southern yellow pine (SYP). Typically SYP commands a premium price relative to WSPF. Those 2 grades have inverted recently, which seems like evidence of heavy Chinese demand.
Nevertheless, investors like to use the lumber charts as confirmation of the rising tide in homebuilding stocks. This is exactly what I’ve talked about with investors a couple of months ago when I told people to buy selected builders to play the ‘hope trade’ in housing. The Hope Trade has worked for six years in a row, beating the market by ~11% on average from mid-November to Super Bowl Sunday. I figured this would be year 7, and so far it’s working as expected. Our analyst favorite name, KB Homes (KBH/$13.61/Strong Buy) has led the way in December, up ~26% month to date.
But the Hope Trade has an expiration date. The reality, unfortunately, is the U.S. housing really isn’t improving all that much. Sales remain tepid, mortgage rates have risen sharply, inventory is back on the rise, and consequently home prices should remain under modest pressure for most of 2011. The good news is the economy is clearly in recovery.
People figure that means a sharp turnaround in housing is just around the corner. I agree, housing will eventually recover back to trendline levels of production, but it won’t happen in 2011 and probably not in 2012 either. The bull argument seems to center around the past few years of below trend production, creating a level of pent up demand that will be unleashed once job growth starts to pick up. Sounds great in theory, but the practical application is that the housing recovery will look more like a boat hull than some kind of sharp V-shaped pattern. The last time we saw a massive jump in housing starts coming out of a recession was 1983 when starts jumped 60% y/y.
But housing conditions in 2011 are very different than in 1983. First, we still have significant excess vacant inventory overhanging the market (2.8 million units by our last count). In 1983, we were actually under built relative to normalized vacancy.
Second, interest rates are rising. In late 1982, mortgage rates dropped 300 bps in a couple of months, unleashing a wave of demand in 1983. Thirdly, 23% of all mortgages are underwater, trapping a tremendous number of people in their current home. Fourth, demographics were strongly in favor of homeownership in 1983, not so much in 2011.
And finally, in 2011 we are exiting a financial crisis started by residential real estate. Meaning hundreds of banks are still trying to clean their books of busted residential projects and bad mortgages. The private homebuilding industry, which is still 65% of the market, simply can’t get the credit and new development loans they need to re-start the construction machine.
So that’s a very long winded way of answering the question, but the short answer is that participants should enjoy the ride in builder stocks while it lasts. However, the reality is that housing in 2011 isn’t going to be all that much improved relative to 2010. It should be better, but people looking for some kind of 50% snapback in housing starts, and sales, are going to be very disappointed.”
The call for this week: The Volatility Index (VIX/16.47) is down to the “complacency levels” seen last April right before a 17% correction. Ditto, Investors Intelligence data shows advisory sentiment approaching the bullish extremes of October 2007.
Meanwhile, stock market leadership is narrowing, internal momentum is waning, and every macro sector except Utilities is overbought. Additionally, correlations between various asset classes are decreasing, implying that investors are becoming increasingly selective. All of this suggests more caution as we enter the new year. That cautious January strategy is reinforced in a report from Citigroup’s technical analyst Tom Fitzpatrick, who chronicles previous dramatic multi-year declines, like we experienced between 2007 – 2008, followed by strong rallies like 2009 – 2010, and what tends to occur in the succeeding January. I have
recreated the historical data in the table on page 4. However, don’t get too bearish because any correction should be for “buying” and not for “selling” because the primary trend remains “up.” Indeed, last week, for the first time in 22 months, Lowry’s Buying Power Index rose above Lowry’s Selling Pressure Index confirming the bullish trend. Still, I think the strategy of hedging select stock positions, which have accrued large profits, makes sense in the short/intermediate-term. And don’t look now, but North American
Energy Partners (NOA/$11.78), rated Outperform by our Canadian energy analysts, has broke out in the charts to the upside on big volume.
