TopTurn Blog

What's in the News with TopTurn

  • Trailblazing: The Real Power of the Lone Wolf Mar 21, 2017
    On a cold day in late December 2011, a wild wolf was confirmed in California for the first time in nearly a century. Wildlife officials have indicated that the lone male wolf, dubbed OR-7, made the long, solo journey to the state from northeastern Oregon. We all imagine ourselves as unique individuals. Most of us, more

    On a cold day in late December 2011, a wild wolf was confirmed in California for the first time in nearly a century. Wildlife officials have indicated that the lone male wolf, dubbed OR-7, made the long, solo journey to the state from northeastern Oregon.

    We all imagine ourselves as unique individuals. Most of us, in some way like to think of ourselves as human versions of OR-7, walking our own road, unlike anyone else.

    contrarian investor

    While it’s true that we all have specific characteristics that distinguish us from the crowd, the majority of us comply with some set of rules most of the time. From stopping at traffic lights, to attending school and work, to walking on the sidewalks instead of the grass, choosing to be harmonious with the people around us is important to maintaining the structure of our society.

    We are all motivated to conform, and the reasons we conform are all very similar. We conform to be socially accepted and avoid rejection, to accomplish group goals, establish and maintain our identity, to align ourselves with others we admire, and – most importantly, at least for this discussion – to be correct. We love being right.

    We all aim to be accurate and correct in our judgements and observations, and we frequently rely on social cues to aid us in analyzing the situations we face. In a 1996 study on conformity, researchers sent several tasks to their student volunteers. When given a task of low difficulty, the students relied less on social supports and more on their own knowledge and experience. When given tasks of greater difficulty, the students relied more heavily on those around them for cues on how to arrive at the right answer. The reality is that we all react in the same way.

    Wisdom can be found in crowds, and listening to multiple perspectives while making decisions can also be wise. But sometimes, crowds lead us astray. Nowhere is this more acute than in investment management. This is definitely one place where you will emerge victorious with far more frequency when you make a lone wolf decision, and run in a different direction from the pack.

    Recently, we were reviewing a specific group of Exchange Traded Funds (ETFs). These ETFs were large enough that they had decent trading data over the past 5 years. Out of the 1200 or so of these ETFs we reviewed, only four of them ranked in the “oversold” or “unloved” arena. The balance of the others were performing remarkably well, showing an incredible – albeit potentially unsustainable – rate of growth.

    If you were sitting on the sidelines, with cash in your hands, you might look at the large group of “hot” ETFs and think, “somebody knows something that I don’t”. You might see this as a large group of investors, many with access to research you don’t have, many with access to information the others don’t have, and all of them are throwing their money at this group of ETFs. You might want in.

    If you turned another direction and started looking at those four ETFs that were not doing so well, you might see that they were all overly weighted in a particular type of industry or sector, one that has not really given anyone a decent return for some time, with media reporting that the influential bodies that make decisions over that industry are not indicating significant change anytime soon. This investment type looks to be going nowhere. Investors are finding other places to put their money.

    Our natural, and fairly logical, response is to put our money where the group is putting theirs, in the 1,196 funds that are doing well, despite the potential for continued growth being unsustainable. We are reliant on the belief that the crowd has, across that wide range of people, access to a collection of knowledge that is pointing everyone in the right direction. Those same people are staying away from that other investment type, because it hasn’t made anyone money for years,

    It’s very, very difficult to fight against our instinct and desire to join the herd. It’s hard to be contrarian – it simply doesn’t seem to make great sense.

    The reality, however, is that we make money in the markets when we sell high and buy low. That means someone else has to like what you’re selling well enough to buy it when it’s high, and dislike what you’re buying well enough to sell it for cheap.

    That means you have to sell the investments that other people are buying. The ones that people say you’re crazy to leave, right now, when the party’s just getting started.

    That means that you have to be interested in ideas that others are not. That means that you have to put your money in the places that other people are getting out of – where they’re selling cheap because they don’t agree with you on where it’s going. Environments that present opportunities are those that look less-than-fantastic at first glance. They’re the ones investors might be walking away from, or aren’t even aware of. We know this intellectually, but to take that risk, when everyone else thinks it’s a bad idea, is incredibly difficult.

    When it comes to making good judgement calls and great decisions, investment can be one of the most difficult arenas in which to practice. It requires not only diligence and process, information and analysis, but also the incredible mental strength to go against everything that our nature tells us to do: follow the crowd. Taking advice from multiple sources and then making a decision seems only logical. But doing this is exactly how investors end up with portfolios that simply follow the market through its exciting rises… and harrowing falls.

    The investor who consistently makes decisions away from the crowd, following their own process, and making, what may at times seem like offbeat decisions, is far more likely to win.

    The concept – buy low, sell high – is easy. But the implementation is hard, because it goes against how we’ve learned to behave in nearly every other scenario. Being a lone wolf means that there are times when you can see the rest of the pack, over there, enjoying a feast at which you chose not to attend.

    But it also means there will be times when you are enjoying a much larger feast, and are the only guest at the table.

    ~Greg Stewart, CIO

     

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  • 2017 – Reality or Reaction? Feb 27, 2017
    As I sat with a client recently, we discussed the knee-jerk reactions that occurred in the wake of the presidential election. First, the world markets were down heavily overnight, but on the following day, once the US trading session was done, the markets closed on an upward swing and proceeded to rally. For about 5 more

    As I sat with a client recently, we discussed the knee-jerk reactions that occurred in the wake of the presidential election. First, the world markets were down heavily overnight, but on the following day, once the US trading session was done, the markets closed on an upward swing and proceeded to rally.

    For about 5 weeks after the election, a stock portfolio would have done quite well, and then meandered around from there. Bonds, on the other hand, were slammed.

    Both results were due to emotional, automatic responses to possibility. They weren’t reactions to new or active change. They were reactions to expectations.

    We’ve seen markets react negatively to social media – not actual news or financial reports, but commentary that may or may not be founded on fact. We’ve seen the stock prices of large companies like Boeing or Ford targeted by tweets and the resulting downward turn in their price and yet… after time has passed and the short attention span of social media pundits transfers to another company, we find that the initial response didn’t end up being the right one.

    You can’t base an investment strategy on rhetoric, emotion, and expectations.

    Knee-jerk reactions happen to all of us – in the words of English rock band Level 42, “we’re only human after all’. What can set you apart is whether you choose to follow that initial response and turn it into action.

    For instance, if you have properly constructed a diversified portfolio, at any given time you’re going to have both winners and losers. You’re not going to have all winners – that’s not how a diversified portfolio works. If you are trying to control volatility and establish a steady rate of return that will help you meet your financial goals, then you’re going to see some investment vehicles riding high while others ride low.

    When you review your statement, though, what is the first thing that you consider? Like most people, you will likely question whether or not it makes sense to keep the loser. Should you sell it now? Should you move the funds somewhere else, perhaps to this winner you happen to be holding, the one that has been trending upwards since your last review?

    Some of your investments are going to be up while others are down, and then they are going to change places. Most investors have had an experience of selling something that was dogging their portfolio, only to kick themselves a year later when they watched it soar.

    As we move forward into 2017, will the reality be anything close to the reaction?

    Uncertainty is everywhere right now. For long-term investors, uncertainty can actually be a positive signal. If there is more pessimism than optimism, then this could set the stage for a potential upswing. Taking a contrarian perspective, and moving against the crowd, lends itself to opportunity.

    While this is obvious in theory, it can be very difficult to put into practice.

    The easy trade, the trade that people want to jump on, is the one that just went up 15%. The hardest trade – the one that pays off – is the counterintuitive one. It can be incredibly hard to sell after that 15% leap, and buy an investment that has taken a beating. The harder it is to buy something, the greater the likelihood that it will end up being the right choice.

    What if you decided to invest in the S&P500’s top 10 highest market cap stocks, and hold them indefinitely? How would they perform, versus the index overall?

    The results of this strategy are not what most people would expect. The reality is that the highest market cap stocks, the ones that have been driven into the stratosphere, got there by becoming everyone’s favorite stock at some point. Universally loved. If you happen to invest into it at that point, who is available to drive the price continually higher?

    Over the long term, your real return since 1972 would have been 548%. If, on the other hand, you had invested in the entire index over that same period, the return would have been 7991%.

    Going along for the ride, picking the famous names, the ones everyone is investing in, is often the wrong choice.

    You have to watch out for the emotions that occur at the extremes. Whether markets are moving upwards, or falling back, or if sentiment is uncertain, fearful, or even incredibly positive, you need to stop and ask yourself if the actions you are contemplating are being driven by the correct sets of data.

    What is the value situation? What is the fundamental view? What is the technical view?

    It’s more difficult to put into practice than most people realize. Think gold about five years ago, they were pushing for 2000 and now it’s dropped all the way to 1000. There were people buying gold hand over fist… convinced that it would continue to climb. Now they’re saying they bought it for insurance.

     

    ~ Greg Stewart, CIO

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  • Greg Stewart’s Surf Advisory – A Study of Expectation vs. Reality Jan 25, 2017
    Rarely do things play out as planned.  When we started 2016, people weren’t expecting Brexit, people weren’t expecting Trump, and to some degree, many people weren’t expecting the Fed to raise interest rates. What was expected – a denial of Brexit, President Hillary Clinton, and a continuation of stalled interest rates – was priced into more

    Rarely do things play out as planned.  When we started 2016, people weren’t expecting Brexit, people weren’t expecting Trump, and to some degree, many people weren’t expecting the Fed to raise interest rates.

    What was expected – a denial of Brexit, President Hillary Clinton, and a continuation of stalled interest rates – was priced into the market. Everyone had already positioned themselves to take advantage of these prospects.  When things didn’t go as expected, market shocks occurred.

    What are the current return expectations for the market?  HIGH – as much as 20% for the year, according to some analysts. Typically, analysts are over-optimistic, and they often come down (or get knocked down) from those lofty points. No one ever gets it completely right. Expectations like these can be hard for companies to match.  Even if company earnings are up 10-15%, if they don’t hit the target, share prices, and markets react negatively.

    Why?  Expectations. Investors will have positioned themselves to take advantage of those 20% expected returns. Should companies miss, they are essentially underperforming and the price that investors were willing to pay based on previous expectations will drop, based on reality.

    Boy with Telescope 700 px

    Presidential Changes: Reality, Fundamentals, and more Expectations

    The market expected Hillary Clinton to win the election. It was repeated around the industry, and in the media, that if Donald Trump won, the market would drop 10%. When he did win, equity futures sold off immediately, based on that 10% drop expectation. However, the next morning, when the markets opened, investors started thinking about the realities of this unexpected president.

    Perhaps he will lower taxes, or spend on infrastructure. Perhaps he will reduce regulation. All of these possibilities might be very good for many industries, and of course, good for stock prices. Seemingly, the potential positives outweighed the negatives, and the market rose.

    On the flip-slide, a few weeks ago now-President Donald Trump gave a speech calling out big pharma. Immediately, a number of related stocks went down heavily – NASDAQ biotech was absolutely hammered. Similar things have happened in response to his tweets about certain companies.

    It’s fascinating, because we know that there isn’t a live person who walks over to their trading desk and hits “SELL” on a given set of stocks simply because of one small sentence in a speech or 140 characters on social media. That just doesn’t happen.

    What does likely happen is that an algorithm gets programmed to take action if Donald Trump mentions a specific set of words in a negative way. At the end of the day, knee-jerk responses – even if those knees are being jerked by computers – have probably occurred. Reactions like these are rarely profitable in the long term, as they only take into account extremely short-term views and behaviors.

    Over the long term, some of the new administration’s proposed changes, such as tax cuts, repatriation holidays, and so forth, could be very helpful to the market.  History suggests that a portion of those potential gains might go towards dividends and buy-backs, which would be good for stocks and the investors who own them.

    Other changes, such as stimulus and infrastructure spending, will probably take a little longer to work their way into the economy. First, the spending must be approved, then the projects must be approved, and more steps will follow before funding is released. Consequently, it’s unlikely we’ll see the full effect of any such proposed changes in 2017.

    Typically, the year after an election tends to be positive on average – and that’s a good thing. It would seem that the optimism with which we started the year could actually continue a while longer. As we move into the second half of the year, a lot of the stimulus spending that had already hit the streets during the 2016 election year will start to go away, which might hurt. However, this year, expectations stemming from new infrastructure proposals may help offset this.

    Fundamentals, Discipline, and the Long View

    Our current research indicates that GDP is growing, likely beating last year’s growth, without a single dollar having been spent on infrastructure, and without one single regulation having been cut or revised. There’s already a lot of action being taken without any input from the new administration. Expectations regarding decisions to be made by the new administration are likely already baked into current valuations, and now (as is always the case) it comes back to fundamentals.

    Valuation remains a key consideration – and valuations still appear to be high. In the short term valuations may very well continue to rise, but over the long term there is a lot of evidence to suggest below average returns are on the horizon.

    One of the key drivers to watch will be supply and demand. There must be an increased supply of funds flowing into the market in order to drive prices upward. Changes indicated by the new administration could free up funds and create the supply required to move this market higher.

    2016 started with doomsday predictions and was punctuated by three significant pullbacks. However, investors with a strong constitution and a long-term plan saw these pullbacks as a fire sale opportunity and bought, and subsequently enjoyed the upward swing of the “Trump Bump”.

    Has this wave already broken?  We’ll have to get back to you on that. Meanwhile, of this we are certain: periods of significant stress and worry are the reason a disciplined approach is important. Having a process to review competing information, and the ability to view the variables from multiple perspectives, with the expectation of being on the right side of the big moves, will remain a key to winning in 2017, and beyond.

    Waves About to Break 700 px

    ~ Greg Stewart, CIO

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  • How Billy Ray Valentine Called the Election Dec 6, 2016
    In the 1983 American comedy film, Trading Places, an upper-class commodities broker, Louis Winthorp III  – played by Dan Aykroyd – and a homeless street hustler, Billy Ray Valentine – played by Eddie Murphy – are unknowingly made part of an elaborate bet and social experiment. In short, Valentine is bailed out of jail and more

    Trading Places 700 pxIn the 1983 American comedy film, Trading Places, an upper-class commodities broker, Louis Winthorp III  – played by Dan Aykroyd – and a homeless street hustler, Billy Ray Valentine – played by Eddie Murphy – are unknowingly made part of an elaborate bet and social experiment. In short, Valentine is bailed out of jail and installed in Winthorpe’s former job. He learns the business quickly, using his street smarts to achieve success. In calling his first trade, Valentine refers to the feeling he has that “People are panicking right now because Christmas is around the corner, and no one is going to have enough money to buy their son the G.I. Joe with the Kung Fu Grip!”

    I’ll come back to what Billy Ray has to do with our recent election in a minute.  But, first, just for fun let’s take a look back over the past 40 or so years of presidential election results.  Doing so, we find that in those periods prior to a regime change, the country had generally suffered through some type of negative economic event – usually a recession. Repeatedly, we see a pattern of recession – prevailing party losing power – and a new party taking over.

    Someone once said that a recession is when your neighbor loses his job, and depression is when you lose yours.

    Continuing with that thinking, and Billy Ray’s line of reasoning, let’s dig further into the data during these election time periods.  Looking at median U.S. household incomes on a real adjusted basis – the actual dollars earned by that one person in the United States who lands at exactly the middle of high and low income earners – we find something very interesting.

    Richard Nixon (R) took office in 1973 and served until he was impeached, with the balance of the term carried out by Gerald Ford (R).  What was interesting about this was that the election that brought in Jimmy Carter (D) in 1976 was preceded by a significant drop in real median household income.

    The first few years of Carter’s presidency were good for median household income, but then in 1980, it began to drop – right when Ronald Reagan (R) was elected. The recession continued, and was followed by another in 1981, but then a huge expansion in median household income occurred. This expansion continued to the end of 1988, when George H.W. Bush (R) runs for president and is elected.

    Towards the latter part of Bush Sr.’s presidency, you get another huge drop in median household income, and Bill Clinton (D) is elected president in 1992.

    The pattern continues, but fast forwarding a bit, the 2008 “Great Recession” brought about the election of Barack Obama (D). What’s interesting about median household income during Obama’s two terms is that while it has been creeping upwards, it is still below (on a real basis) what it was in 2000.  That’s 16 years of not returning to the income you once had, if you’re the person we referred to earlier who lands right in the middle.

    This becomes a deeper issue when you take a look at incomes across the country, broken into quintiles.  While the highest earning quintile has experienced a nice upward-sloping, growth in income between 1986 and 2015, the bottom three quintiles have had a continuous decrease over that same period. 60% of households have seen no increase in income whatsoever over nearly 30 years!  In fact, they’ve seen a decrease in real household income over the past 16 years, and for the bottom two quintiles, the problem is even more pronounced.

    We’ve heard time and time again that we’ve recovered from the Great Recession, yet the majority of people are not better off than they were 16 years ago.

    For everything that has been said about social justice, the populist tone in our politics seems to boil down to individual households and how they are doing financially.  Clearly, when people are choosing between a vote for social justice or a vote for their own survival, they will inevitably vote for survival.

    The results of this year’s election were less about racial tension, building walls, and social politics than many people would like to believe.  The correlation between recessions, household income, and regime changes is too significant to ignore.

    James Carville, campaign strategist of Bill Clinton’s successful 1992 presidential campaign coined the phrase, “It’s the economy, stupid”. Billy Ray Valentine may have expressed it differently, but it means the same thing… economics can affect the way people feel, and push them towards accepting – or even promoting – a change.

    Market Reactions

    Usually there is a snap reaction in the markets to big changes, and we’ve seen that happen post-election. The markets have looked at the key economic issues the new presidential regime campaigned on – lower taxes for businesses, less market regulation, etc. – and decided that these changes would be good for company profits and market growth. (It’s important to remember that there’s not a single proposal actually sitting in Congress to make any changes at this time. Conjecture has created those market reactions, not facts).

    So what do we do? Take a deep breath.

    First and foremost, we can’t make longer term decisions based upon short-term hopes and fears.  Secondly, while those immediate knee-jerk reactions could turn out to be correct, we don’t want to buy into these areas after they’ve already experienced a jump.

    Typically, the first couple years of a new president’s term aren’t the greatest.  The current bounce may simply be because some people were holding back due to the election, and are now making investments.

    Either way, rarely do changes such as these turn out either as great or as terrible as we have imagined.  If we were expecting the worst, it’s probably not going to be that bad.  If we were expecting the best, it’s probably not going to be as great as we thought.

    We haven’t changed our perspective: the market remains overvalued, and long-term returns don’t look amazing. We continue to seek opportunities in unexpected places.

    For now… Wishing you and your loved ones the gifts of the season – Peace, Joy, and Hope for a Happy and Prosperous New Year.

    Ornaments on the beach 700 px

     

    ~ Greg Stewart, CIO

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  • What to do in the Wake of the Election? Just Keep Paddling! Nov 14, 2016
    I was in San Diego recently, attending a conference. My wife and I decided to hang around a few extra days to enjoy the city and relax a little bit. We spent one of those days at La Jolla Shores, a small beach community that stretches from the sea cliffs of La Jolla Cove to more

    I was in San Diego recently, attending a conference. My wife and I decided to hang around a few extra days to enjoy the city and relax a little bit. We spent one of those days at La Jolla Shores, a small beach community that stretches from the sea cliffs of La Jolla Cove to Black’s Beach.

    Keep Paddling

    La Jolla Shores is considered one of the best spots for beginner surfers, with very reliable waves. It was the perfect spot for the surf competition we found, which was filled with children and teenagers. It was interesting to watch the competition. It wasn’t much like the professional surf circuit – the kids sure fall down a lot. They would get up, ride for a little bit, and they would fall down. Then they’d paddle back out, get up, and try again.

    It reminded me of how, sometimes, when we as adults experience something negative, we don’t tend to forget it very easily. We often will keep the “bad thing” in our mind. Many people maintain a fear borne out of the Great Recession. It was pretty recent, and that movie reel continues to play over and over in their subconscious. It’s hard to forget the fact that your investments lost 50% of their value. It’s something that remains in the forefront of many investors’ minds.

    Yet, to be successful in investing – or anything, for that matter – a couple of things have to happen. (more…)

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  • The Big Short… That Came Too Soon Oct 24, 2016
    Back in the mid-2000s, a friend of mine was a trader at a small hedge fund firm. This firm had completed a great deal of analysis at the time, and identified the sub-prime lending issues that eventually came to a head in 2008, years in advance. Much like Michael Burry, who is played by Christian more

    Big Short

    Back in the mid-2000s, a friend of mine was a trader at a small hedge fund firm. This firm had completed a great deal of analysis at the time, and identified the sub-prime lending issues that eventually came to a head in 2008, years in advance. Much like Michael Burry, who is played by Christian Bale in The Big Short, they knew that these issues would cause incredible disruption to the markets, and they carefully positioned quite a bit of money to take advantage of the impending fall.

    But no one wrote a book or produced a movie based on their excellent analysis and subsequent profits. Why?

    It turned out that they took these positions about 3 years too early. The real estate market continued to ramp upwards, prices remained on fire… and their investors pulled the funds a year before the market collapsed.

    This small hedge fund was right, but they were right early, and they never got to experience the fruits of their research. The firm closed. Their investors missed a great opportunity, and in all likelihood, suffered alongside everyone else in October 2008.

    An analyst can be exactly spot-on with their hypothesis, come up with a great idea, implement it, and can still lose – because investors may not have the patience to see it through to the end.

    You may be right, but if your timing is off, you won’t get the opportunity to benefit from it.

    Patience is, indeed, a virtue

    Howard Marks, the founder of Oaktree Capital and Chair of the Investment Board at the University of Pennsylvania for the first decade of the century, was wildly celebrated for outperforming during both of the major market crises of that decade – the DotCom Bubble and the Subprime Lending Crisis.

    In a 2012 memo Assessing Performance Records: A Case Study, Marks recounts his experience, and proposed that, when drawing any conclusions about the efficacy of an investment strategy, you must have a record spanning “a significant number of years,” and a period that “includes both good years and bad, enabling us to assess performance under a variety of circumstances”.

    During his tenure, Marks experienced exactly that. When he took over the board near the end of the tech boom, the endowment fund was underperforming peers by as much as 7%, thanks to their avoidance of tech stocks and venture capital. Marks remained conservative throughout, despite the allure of the large gains being enjoyed by his Ivy League peers, and after a decade of management, his stewardship was deemed a success.

    But what if the board had lost their trust in his strategy after 4, 6, or 8 years? It would not have been sufficient time to allow the strategy to run its course, and the fund would have likely underperformed.

    Past Performance is Not Indicative of Future Results

    You’ve heard it before. Despite the fact that we are told again and again that past performance really doesn’t tell you what future performance will be, people continue to make investment decisions based on exactly that. Investors often turn to Morningstar in order to determine which fund should hold their money. Morningstar ranks funds on a 1 to 5 star rating, which is based upon risk-adjusted performance, relative to their peers.

    Since so many investors are using these ratings to look backwards, why not peer a little further and look at the funds that held 5 stars ten years ago, and determine where they are today?

    The Wall Street Journal did exactly that in 2014, and what they found would surprise many investors. Many of the funds who held 5 stars 10 years ago had dropped significantly in the rankings. This is exactly the kind of data that encourages investors to throw their hands in the air and escape to the potential “safety” of a passive index funds.

    If you dig a little deeper into the data, however, you will find that many of the top-rated funds that have been producing consistent returns over that same period of time have both low volatility and reduced exposure to risk. Of the funds that managed to keep their 5 star rating for 10 years, a significant number were those with a balanced mandate.

    The key here is that investors should not necessarily be seeking the juiciest possible returns, as these tend to be highly correlated with volatility. High volatility is not a great indicator of long-term positive results, though it can look pretty amazing in the short term. If your intention is to invest for the long term, a fund that values low volatility and reduced risk will win out.

    Looking Forward

    Big Short

    A recent study on the Dow Jones indices indicated that an investor randomly browsing the 700 or more top performing funds would have less than a 1% chance of picking one of the funds that were still in the top quartile just four years later. This could lead an investor to rationally decide that, if they can’t find the right fund, they may as well just invest in the index.

    But how should you really look at this? Is there a way to look forward, instead of backwards? How do you plan for the next decade?

    As indicated by those Morningstar funds that held their rating, a lot of successful investing is about protection – it’s how you can really make up performance. If you can mitigate risk on the downside, in a systematic way, you can end up completely crushing indexes.

    At the same time, we need to allow our strategies time to play out, and avoid the temptation of investing long-term funds into strategies that have short-term benefits – which is not to say we shouldn’t take advantage of short-term gains. It should just be done within the greater context of a patient, long term strategy.

    Sometimes we become so focused on what’s happening this month, this quarter, this year, that we lose focus on our eventual goal, which is to be in the right place for the next 5 or 10 years.

    Like those top-ranked Morningstar funds who held their position for 10 years or more, and like Howard Marks, who held a conservative allocation for a decade, we can avoid the errors of that now-defunct hedge fund’s investors, who pulled out too soon, and chased performance.

    At Topturn, we’re remaining steady, taking short term gains within a long-term, patient strategy. Like you, we’re in it for the long run.

     ~ Greg Stewart, CIO

     

     

     

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  • The False Security of Cash and Asset Allocation Strategies Sep 26, 2016
    You’re getting ready to retire. Everything you’re reading right now is stating that it’s not a great time to be in bonds. They’re yielding very little; however, people who are about to retire typically want to have a little more security, and a little less volatility. You may, at this point, be wondering which direction more

    You’re getting ready to retire. Everything you’re reading right now is stating that it’s not a great time to be in bonds. They’re yielding very little; however, people who are about to retire typically want to have a little more security, and a little less volatility.

    You may, at this point, be wondering which direction to turn, since traditional market places are not providing you with an ideal investment vehicle.

    The 4 Year Cash Strategy

    A friend recently sent me an article advocating a strategy wherein a retiree removes 4 years’ worth of income from their portfolio and puts it into cash. During the following 4 years, the retiree spends from this cash, rather than drawing from their portfolio.

    This strategy is based on the idea that, outside of the Great Depression, the market has always recovered within a 4-year period. So long as a retiree keeps their emotions in check, and only pays attention to the 4 years’ worth of income that they hold in cash, assets will recover from any downturn, and your retirement will remain on track right?

    These sorts of ideas, while interesting, tend to come down to timing. People look at research such as this and believe it’s fairly easy to apply in real life, but that can be a problem in that this kind of research uses very long historical rates of return and standard deviations.

    Let’s assume you are a retiree with a $1,000,000 portfolio. You want to take out $50,000 per year to live on, and that the rate of inflation is a fairly manageable 2%.

    Let’s go backwards and have you retire in 1999, right before the bursting of the tech bubble.

    You’ve set up your portfolio, you’ve taken out your $200,000 cash (4 years x $50,000), and you walk away to enjoy your retirement for the next 4 years. Your $800,000 remaining “invested” portfolio goes to work.

    You come back 4 years later to find that the value of your portfolio, between what you’ve spent and the difficult market activity over that time frame, now stands at just $600,000.

    Deciding to stay the course, you take out another 4 years’ of income, leaving a $400,000 portfolio to work while you enjoy your retirement.

    The bottom line? As shown in the attached graph, after 16 years, or 4 cycles of this activity, you’ve almost entirely exhausted your portfolio.

    Was the strategy a success? That depends on whether you were age 65 or age 82 when you put it in place.

    The 100 Minus Your Age Asset Allocation Strategy

    Another common asset allocation strategy is to deduct your age from 100. The balance that is left over is invested in equities, while your age is invested in bonds and other fixed income investments.

    For example, if you were 65 today, under this strategy your asset allocation would be:

    Employing a strategy like this today could set up people for significantly lower performance than they’d been expecting – or worse, needing.

    There’s a false sense of security around this portfolio structure that doesn’t really give credit to timing as an important factor, when you are deciding to live off of your investments.

    You have to look at where we are today, and what we can count on, before making asset allocation and withdrawal strategy decisions. You can’t rely on a “rule of thumb” that was created with a different market environment as a backdrop.

    Supply & Demand: Household Financial Assets

    Just imagine for a minute that there are three people in a room. All three people have committed a certain amount of money to the market – all of their excess money.

    If there are no other people left in the room, who is left to push the market higher?

    The investment markets are no different than any other in that they respond to both supply and demand. If there is no one left to create demand – no more money flowing into the market – then how will prices be pushed higher? If prices are not pushed higher, then the value of the original investment these three people made into the market will not change.

    We can monitor the commitment that regular people make to the market through a measurement of the Percentage of Household Assets currently invested in stocks.

    Then, when you compare the percentage of household assets against the return in the market, a simple inverse relationship is uncovered.

    As more people commit higher levels of their assets to the market, the opportunity for prices to rise decreases. As people drop out of the market, the opportunity for prices to rise increases.

    By way of example, in 1983 27% of Household Financial Assets were committed to the market – one of the lowest ratios in the past 65 years. The subsequent rolling 10-year return in the S&P 500 was 18% per year.

    Contrast this with the year 2000, when 62% of Household Financial Assets were committed to the market – one of the highest ratios over that same period. The subsequent rolling 10-year return in the S&P 500? -3%.

    If you had retired in 1983 and used the 4 year cash strategy, you might be a very happy retiree. However, if you retired in 1999, like our retiree in the previous example, and used this strategy, you’d be decidedly less cheerful.

    So, the next time someone misquotes Warren Buffet to tell you that you can’t “time” markets, reference the Oracle of Omaha accurately and let the uninformed investor know that while we may not be able to exactly time markets, we can, and certainly should, have a rough idea of their current value. This type of “timing” is, unfortunately, critical, and quite often people planning their retirement do not give it the justice it warrants.

    What is in the control of the investor right now?

    For the most part, this year has been one of those hated “rally” years – a most decidedly unloved year. No one expected the market to go up to the extent it has, and this has largely caught everyone off guard.

    No one wants to miss out on rallies, and in the short run, there may be real opportunities to benefit, but you have to be cognizant going forward. You have to have a strategy that is aware of long term returns, understands what you need to protect, and has a game plan for what you will do when the market does eventually roll over.

    Part of this is having other sources of return in your portfolio. If over time these alternative sources can generate 8-10% with a different return or risk portfolio than stocks or bonds, you may find that in the years when stocks are not doing particularly well, you are still on track.

    Timing, of course, matters in any analysis. You need to focus your efforts more broadly. You need to understand the environment you are in, and what that means for you and your portfolio.

    At Topturn, we are constantly seeking opportunities both in the traditional markets, but also outside, in areas where others aren’t yet surfing. At the same time, we’re paying attention to our environment, and watching for sharks in the water.

    ~ Greg Stewart, CIO

     

     

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  • US Political Cycles Sep 14, 2016
    Even more uncertainty was interjected into the US political arena with the Brexit vote. Polls have narrowed between the two major candidates, potentially creating political headwinds for the market in the short-term. In the past, the market has tended to bottom once the outcome of the election appears to be certain. At the moment, a more

    Even more uncertainty was interjected into the US political arena with the Brexit vote. Polls have narrowed between the two major candidates, potentially creating political headwinds for the market in the short-term.

    In the past, the market has tended to bottom once the outcome of the election appears to be certain. At the moment, a lot of people are dissatisfied with both major candidates. Against that backdrop, there are questions as to who will ultimately be our next president. The markets don’t appear to know, and that uncertainty continues to be reflected. (more…)

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  • The Post-Brexit World Sep 8, 2016
    The Brexit vote produced some very short term volatility, with two strong down days followed by three strong up days – putting us pretty close to where we were before the vote. Here are our takeaways from that experience: 1.  A lot of fear was built up around this event, and given the scope of more

    The Brexit vote produced some very short term volatility, with two strong down days followed by three strong up days – putting us pretty close to where we were before the vote. Here are our takeaways from that experience:

    1.  A lot of fear was built up around this event, and given the scope of that build up, the shock was not as great as it could have been. It seems people were mentally prepared for a negative vote.

    2.  The two down days that followed the vote results appear to have been a knee-jerk reaction more than anything more serious. There was probably quite a bit of algorithmic trading which took advantage of fear. When people sell in a panic, that’s when quick money can be made… or lost, depending on which side of the equation you are on.

    Panicking didn’t work for anyone after this event, and it’s never the right strategy. (more…)

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  • Interest Rates and Economic Forces Sep 1, 2016
    For the balance of the year, safe assets are predicted to provide low returns. For example, the U.S. 10 Year Treasury Bond is now yielding around 1.5%. Returns like that don’t exactly light a fire. When a decade-long investment provides a nominal return that is below inflation, it doesn’t signal a fabulous economic situation. In more

    For the balance of the year, safe assets are predicted to provide low returns. For example, the U.S. 10 Year Treasury Bond is now yielding around 1.5%. Returns like that don’t exactly light a fire.

    When a decade-long investment provides a nominal return that is below inflation, it doesn’t signal a fabulous economic situation. In fact, it seems to signal caution, and points out that things are not exactly has hunky-dory as some media outlets would lead us to believe.

    Several forces are at work. Skepticism about growth of the economy. Falling real wages – despite the fact that we have had a strong comeback in unemployment. Dissatisfaction with the overall direction of the economy, which is below what government statistics are demonstrating.

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    While low returns in the U.S. definitely look and feel terrible, there are more difficult situations around the world. Interest rates in some countries, such as Japan, Switzerland, and Germany, are actually negative for the next decade. As an investor, choosing between a negative 0.7% foreign bond and a +1.5% U.S. treasury bond, suddenly becomes a no-brainer.

    The global environment will likely keep a lid on any rise in interest rates in the near future. The Brexit situation gave cover to the Federal Reserve to take hikes off the table for the time being, and the markets certainly aren’t pricing in a hike.

    ~Greg Stewart, Chief Investment Officer

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