Sell in May and go away
This old Wall Street adage came about as a description of how many traders on Wall Street would take summer vacations and did not want to be holding stocks when they could not monitor the markets. More recently the phrase has been rejuvenated to reflect the fact that the performance of the stock markets has been particularly lousy the last few summers and you would have been better off not holding stocks from May through October.
While we did not engage in market timing by selling all securities at the beginning of May, we have been making portfolio modifications to decrease risk across all portfolios. In May, we witnessed a widening debt crisis in Europe, weak economic data in the United States, slowing growth in China, and an ugly two-billion dollar trading loss at J.P. Morgan. These headlines from the business pages of newspapers increased investor anxiety and explained some of the decline in stock prices. The good news is that the risk reducing measures taken by Oak Wealth Advisors are decreasing the losses during the volatile times we are experiencing again this summer. While we did not sell everything and abandon the markets, we are continuing to make adjustments.
And I did go away. In early May, I attended the three-day Chartered Financial Analyst Annual Conference in Chicago. I am grateful that the organizers of the event scheduled it downtown so even though I was “away,” I was never far from my home or office.
I thought you might find some of the key insights that I heard at the conference to be of interest. Unlike brokerage firm conferences where the focus is on how to sell clients more investment products that will make the brokerage firms wealthy, the majority of the presenters at the CFA conference were academics or industry experts. They were focused on ways to decrease risk in client portfolios and avoid making investment management mistakes.
Not surprisingly, Greece was a major focus of many of the international investing and political experts who spoke during the conference. The consensus was that Greece would eventually be ousted from the European Union by sometime in 2014. While opinions differed as to the timing, there was little optimism that Greece would remain in the EU long-term. The biggest concerns related to its departure are the risk of contagion (fears that other countries will also be eliminated from the group) and that the EU will go overboard to keep Greece in the Union, leading to a significant recession throughout all of Europe.
The increasing importance of the Emerging Markets in the world economy could not be missed. The Emerging Markets, which include China, India, Brazil, Russia, and Mexico among others, are growing much more rapidly than the developed economies of the United States, Europe, the United Kingdom, and Japan. In fact, their growth rate over the past twenty years is astonishing.
By way of comparison, at the end of 2011, the United States represented 44% of the global market capitalization while Greece was only one-twentieth of one percent!
While all Oak Wealth Advisors client portfolios have been adjusted to underweight international stocks this summer, the relative weighting of the Emerging Markets mutual funds to the developed country funds has been increasing. We expect this trend to continue as the Emerging Market countries have faster growing economies and little if any sovereign debt, making them relatively more attractive than other countries.
The next area of international investing that is being watched and researched is the Frontier Markets. Countries such as Vietnam, Bangladesh, Kazakhstan, Sub-Saharan Africa and parts of the Middle East are included in this group. Much like the emerging market countries in the 1980’s, these markets have the common attributes of relatively unstable governments, little if any middle-class, limited exports, and limited investment opportunities for outside investors. Only time will tell if this segment of the world’s economy will follow in the footsteps of the Emerging Markets.
For now, the investment opportunities are very limited and risky but we will continue to watch this group develop and will remain on the lookout for attractive investment opportunities.
The conference also yielded a number of thoughts regarding the benefits of alternative investments. “Alternative investments” was used to describe any investment other than stocks, bonds, cash, or mutual funds that hold stocks, bonds, and/or cash. Most alternative investments are expensive for investors to own, not tax efficient, not transparent, and illiquid. However, the exclusivity of owning them along with the potential for huge returns has driven investor demand. The most powerful comment came from a well-respected industry consultant. He stated that managing the risk in a portfolio can add return to the left side of the decimal point while picking managers or investment products at best can add return to the right side of the decimal point. He emphasized the risk reducing benefits of alternative investments while downplaying their return potential.
His thoughts and those of several others emphasized how prudent selection of alternative investments can help investors lose less in down markets. Oak Wealth Advisors uses a number of alternative investments to add portfolio diversification, increase portfolio income, and decrease portfolio risk. The mutual funds we use are among the lowest-cost alternatives available, have transparency and monthly reporting of holdings, and daily liquidity. While they should help to increase the long-term investment results of portfolios, none of them individually is expected to deliver significant returns.
The pinnacle of the conference was a talk given by Daniel Kahneman who is a Professor of Psychology at Princeton and a past winner of a Nobel Prize in Economics. He shared some details from his research career. Among my favorite insights was the need that humans have to seek causality. A great example is how the evening news provides explanations to very complex matters in a matter of minutes or even seconds. This gives the viewer piece of mind, even though the causes are simplified and perhaps wrong a good amount of the time. He also shared that confidence about something is primarily related to the cohesiveness of its story rather than the facts behind it. He warned that overconfidence, especially in the investment field, leads to excess risk taking and can be detrimental to wealth creation. It was a good reminder to stay humble and seek as much information as possible before making a decision.
Two final thoughts that Kahneman shared are related to the title of his recent book, Thinking Fast and Slow, which I highly recommend. First, he explained the benefits of systemization and how procedures can improve performance. He emphasized that achieving the desired result is much more important than the speed at which you finish the process. His other concluding point was the importance of slowing down and processing all available information when making a big decision and being cognizant of the risk of errors. When you make fast decisions you are basing them primarily on intuition and emotions. You will almost always make a better decision when you seek additional information, consider the ramifications of different potential outcomes, and weigh all your alternatives.
While Oak Wealth Advisors studies the markets and reviews current research in search of ways to enhance client investment returns and decrease the likelihood of significant losses in client portfolios, we try to do so in a prudent manner. In order to remain disciplined and not fall victim to the dangers of “thinking fast,” we try to evaluate how new ideas will fit with the other elements in a client’s portfolio or planning before implementing any changes.
To conclude, I will leave you with my favorite one-liner from the three days of non-stop financial insights…
“Hope is not an investment strategy.”
–James Montier of GMO