Risky Business
By Yiannis G. Mostrous
MCLEAN, Va.–The markets are known to move–initially in the direction opposite the one that favors my call–when I make a recommendation. But overall, the opinions expressed in SRI get things right; otherwise, my publisher would have suggested a different line of business a long time ago.
So when I suggested two weeks ago (see SRI, 10 May 2006, Don’t Sell In May) that May was not necessarily the time for investors to liquidate their positions and go on vacation (as an old adage has it), one would have been justified in expecting the market to make a fool of me.
And it did, to a certain degree: Global stock markets started selling off that day, in the process shedding around 8 percent of their value, with emerging markets losing 13 percent. See the chart below depicting the recent performance of world markets.
Source: Bloomberg
The only consolation here is that the Flash Alert sent five days later was useful and timely (see SRI, 15 May 2006, Silk Road Investor-Flash). The chart below depicts the emerging markets performance since then (in dollar terms).
Source: Bloomberg
The following longer-term chart depicts the massive rally in global equities since April 2003, providing some context for the recent selloff.
Source: Bloomberg
There are two ways to interpret this chart. The bearish view is that this is the beginning of a period of prolonged market weakness. The bullish assessment is this was a liquidity-driven selloff that, while damaging, shouldn’t scar the markets. Perma-bears argue, of course, that they’ve been waiting for the selloff all along; such opinions warrant no comment.
The view here is that this is primarily a profit-taking selloff. Although it’s not necessarily over, it’s followed previous similar incidents of preceding years, at least in Asia.
The usual suspects–India, China, Taiwan, and Korea–have suffered the most. Indonesia and the Philippines, given their strong year-to-date performances, have also fared poorly. SRI expected Singapore (down 10 percent) to weather the market weakness better than it did.
The speed with which global markets fell suggested that the many big players with substantial leveraged positions that had to be closed at short notice created more havoc. That more than 50 percent of equity funds outperformed the market in the first quarter demonstrates they’re playing the momentum game and may pull their money out quickly.
I’ve been able to talk to institutional traders and they’ve told me that hedge funds have been very active, while other big institutional players–mutual funds and the like–are on the sidelines, trying to decide if now is a good time to add to positions.
My advice: Be very selective. As I noted two weeks ago, high commodity prices hold the key when it comes to projecting the timeframe for this selloff. Prices have gone parabolic and leverage is off the charts. A violent collapse in commodities–in a weakening dollar environment–wouldn’t be the best scenario for investors’ pockets and sentiment. At the same time, investors are generally optimistic, as are most analysts.
My main worry with recent market developments is that investors, market observers and talking heads (your truly included) view the situation as a market correction that will provide an opportunity for bargain buying.
Given this attitude, it’s not surprising that tolerance for risk (as expressed through the JP Morgan Emerging Market Bond Index and Sovereign Debt Spread), although it has weakened some, yielding 220 basis points over the 10-year US Treasury note, as the chart below indicates, remains quite high in the big picture. It remains to be seen if a reversion to the mean will take place. If it does, this selloff has a long way to go.
Source: Bloomberg
Source: Bloomberg
There are no changes to the Portfolio this week, though the suggestions made in last week’s Flash Alert stand.
At the beginning of May I wrote:
I still stand by this assessment.
Finally, Japan remains a favored market as we head into the second half of 2006. The big selloff there was expected–this is why more Japanese stocks were not added in the Portfolio. SRI’s assessment of economic and political issues and the consequent market outlook for Japan will be coming shortly.
A Note To Readers
This being a new service, I’ve received many questions about portfolio construction and stock selection. Let me take an opportunity to reiterate an explanation from prior issues:
The approach here is top-down. I first identify long-term investment themes (or, as my colleagues and I call them, global secular trends). Because of the long-term approach, the Portfolio must be able to endure short-term volatility as long as we continue to be on the correct side of the global secular trend. To achieve this, the Portfolio is being constructed to offer a diversified set of holdings, while I also offer hedging ideas for more complete advice.
A characteristic common to the Portfolio companies is suitability for the new realities of a changing world. They’ll benefit the most from the changes taking place in the global economy.
That said, no one knows how long it will take for the global economy to navigate the secular trend identified here. This is the reason investors need to remain focused and have a portfolio that can last and perform well on a tactical basis. After all, the way to stay in the game is by not losing all the money, and tactical mistakes can cause that. This is the main reason I won’t put convictions above analysis and will avoid suggesting only one type of attitude or trade, especially short-only strategies.
It’s important that you look at the Portfolio as a whole and not as an assortment of stock tips. Although few people will buy the Portfolio in its entirety, you, at the very least, need to buy SRI’s investment theme in order to diversify. Buying only banks or tech companies because you like the stories might offer a reward, but such an approach won’t provide the lasting benefits of the overall Portfolio.
Keep in mind that SRI comes to you weekly and always offers current advice. Adding and subtracting stocks from the Portfolio can be done easier this way. There’s always another week and neither readers nor the editor need to rush. Patience has always been a good thing to have when investing.
MCLEAN, Va.–The markets are known to move–initially in the direction opposite the one that favors my call–when I make a recommendation. But overall, the opinions expressed in SRI get things right; otherwise, my publisher would have suggested a different line of business a long time ago.
So when I suggested two weeks ago (see SRI, 10 May 2006, Don’t Sell In May) that May was not necessarily the time for investors to liquidate their positions and go on vacation (as an old adage has it), one would have been justified in expecting the market to make a fool of me.
And it did, to a certain degree: Global stock markets started selling off that day, in the process shedding around 8 percent of their value, with emerging markets losing 13 percent. See the chart below depicting the recent performance of world markets.
Source: Bloomberg
The only consolation here is that the Flash Alert sent five days later was useful and timely (see SRI, 15 May 2006, Silk Road Investor-Flash). The chart below depicts the emerging markets performance since then (in dollar terms).
Source: Bloomberg
The following longer-term chart depicts the massive rally in global equities since April 2003, providing some context for the recent selloff.
Source: Bloomberg
There are two ways to interpret this chart. The bearish view is that this is the beginning of a period of prolonged market weakness. The bullish assessment is this was a liquidity-driven selloff that, while damaging, shouldn’t scar the markets. Perma-bears argue, of course, that they’ve been waiting for the selloff all along; such opinions warrant no comment.
The view here is that this is primarily a profit-taking selloff. Although it’s not necessarily over, it’s followed previous similar incidents of preceding years, at least in Asia.
The usual suspects–India, China, Taiwan, and Korea–have suffered the most. Indonesia and the Philippines, given their strong year-to-date performances, have also fared poorly. SRI expected Singapore (down 10 percent) to weather the market weakness better than it did.
The speed with which global markets fell suggested that the many big players with substantial leveraged positions that had to be closed at short notice created more havoc. That more than 50 percent of equity funds outperformed the market in the first quarter demonstrates they’re playing the momentum game and may pull their money out quickly.
I’ve been able to talk to institutional traders and they’ve told me that hedge funds have been very active, while other big institutional players–mutual funds and the like–are on the sidelines, trying to decide if now is a good time to add to positions.
My advice: Be very selective. As I noted two weeks ago, high commodity prices hold the key when it comes to projecting the timeframe for this selloff. Prices have gone parabolic and leverage is off the charts. A violent collapse in commodities–in a weakening dollar environment–wouldn’t be the best scenario for investors’ pockets and sentiment. At the same time, investors are generally optimistic, as are most analysts.
My main worry with recent market developments is that investors, market observers and talking heads (your truly included) view the situation as a market correction that will provide an opportunity for bargain buying.
Given this attitude, it’s not surprising that tolerance for risk (as expressed through the JP Morgan Emerging Market Bond Index and Sovereign Debt Spread), although it has weakened some, yielding 220 basis points over the 10-year US Treasury note, as the chart below indicates, remains quite high in the big picture. It remains to be seen if a reversion to the mean will take place. If it does, this selloff has a long way to go.
Source: Bloomberg
Source: Bloomberg
There are no changes to the Portfolio this week, though the suggestions made in last week’s Flash Alert stand.
At the beginning of May I wrote:
While in London I had the opportunity to talk with a group of people in the hedge fund industry, mainly account managers. The bottom line is that, based on our conversations, there’s no fear in their thinking. They’re prepared to buy the dips, and they’re always open to listening to new investment ideas.
Although this is a good sign–in the sense that the market is supported–it’s also a reminder that greed rules the market. You should be a little conservative, as a sudden change in mood can hurt the markets meaningfully. Keeping your powder dry now will only help enhance performance as the year unfolds.
I still stand by this assessment.
Finally, Japan remains a favored market as we head into the second half of 2006. The big selloff there was expected–this is why more Japanese stocks were not added in the Portfolio. SRI’s assessment of economic and political issues and the consequent market outlook for Japan will be coming shortly.
A Note To Readers
This being a new service, I’ve received many questions about portfolio construction and stock selection. Let me take an opportunity to reiterate an explanation from prior issues:
The approach here is top-down. I first identify long-term investment themes (or, as my colleagues and I call them, global secular trends). Because of the long-term approach, the Portfolio must be able to endure short-term volatility as long as we continue to be on the correct side of the global secular trend. To achieve this, the Portfolio is being constructed to offer a diversified set of holdings, while I also offer hedging ideas for more complete advice.
A characteristic common to the Portfolio companies is suitability for the new realities of a changing world. They’ll benefit the most from the changes taking place in the global economy.
That said, no one knows how long it will take for the global economy to navigate the secular trend identified here. This is the reason investors need to remain focused and have a portfolio that can last and perform well on a tactical basis. After all, the way to stay in the game is by not losing all the money, and tactical mistakes can cause that. This is the main reason I won’t put convictions above analysis and will avoid suggesting only one type of attitude or trade, especially short-only strategies.
It’s important that you look at the Portfolio as a whole and not as an assortment of stock tips. Although few people will buy the Portfolio in its entirety, you, at the very least, need to buy SRI’s investment theme in order to diversify. Buying only banks or tech companies because you like the stories might offer a reward, but such an approach won’t provide the lasting benefits of the overall Portfolio.
Keep in mind that SRI comes to you weekly and always offers current advice. Adding and subtracting stocks from the Portfolio can be done easier this way. There’s always another week and neither readers nor the editor need to rush. Patience has always been a good thing to have when investing.