On Straight Talk Money: Should We Worry About 3% Bond Yields?

I joined Peggy Tuck and Chase Robertson this morning on Straight Talk Money. In the first segment, we focus on earnings beats by Boeing (BA), Twitter (TWTR), Blackstone (BX) and others.

 

In the next segment, we confront the elephant in the room: bond yields!

With the 10-year Treasury note now yielding more than 3%, should investors be worried?

 

Are we in the early stages of a bear market? We weigh the odds.

 

In the final segment, we chat about insurance.

You buy insurance to protect against specific losses. But how much is too much? We discuss.

 

 

This article first appeared on Sizemore Insights as On Straight Talk Money: Should We Worry About 3% Bond Yields?

Keeping Perspective: Julian Robertson’s Last Letter to Investors

Growth stocks — and specifically large-cap tech stocks led by the FAANGs — have utterly crushed value stocks of late. It’s been the dominant theme of the past five years. Even the first quarter of 2018, which saw Facebook engulfed in a privacy scandal, saw growth outperform value.

SectorBenchmarkQtr. Return
Large-Cap GrowthS&P 500 Growth1.58%
Large-Cap StocksS&P 500-1.22%
InternationalMSCI EAFE Index-2.19%
UtilitiesS&P 500 Utilities-3.30%
Large-Cap ValueS&P 500 Value-4.16%
Real Estate Investment TrustsS&P U.S. REIT Index-9.16%
Master Limited PartnershipsAlerian MLP Index-11.22

Value stocks in general underperformed, and the cheapest of the cheap — master limited partnerships — got utterly obliterated.

So, is value investing dead?

Before you start digging its grave, consider the experience of Julian Robertson, one of the greatest money managers in history and the godfather of the modern hedge fund industry. Robertson produced an amazing track record of 32% compounded annual returns for nearly two decades in the 1980s and 1990s, crushing the S&P 500 and virtually all of his competitors. But the late 1990s tech bubble tripped him up, and he had two disappointing years in 1998 and 1999.

Facing client redemptions, Robertson opted to shut down his fund altogether. His parting words to investors are telling.

The following is the Julian Robertson’s final letter to his investors, dated March 30, 2000, written as he was in the process of shutting down Tiger Management:

In May of 1980, Thorpe McKenzie and I started the Tiger funds with total capital of $8.8 million. Eighteen years later, the $8.8 million had grown to $21 billion, an increase of over 259,000 percent. Our compound rate of return to partners during this period after all fees was 31.7 percent. No one had a better record.

Since August of 1998, the Tiger funds have stumbled badly and Tiger investors have voted strongly with their pocketbooks, understandably so. During that period, Tiger investors withdrew some $7.7 billion of funds. The result of the demise of value investing and investor withdrawals has been financial erosion, stressful to us all. And there is no real indication that a quick end is in sight.

And what do I mean by, “there is no quick end in sight?” What is “end” the end of? “End” is the end of the bear market in value stocks. It is the recognition that equities with cash-on-cash returns of 15 to 25 percent, regardless of their short-term market performance, are great investments. “End” in this case means a beginning by investors overall to put aside momentum and potential short-term gain in highly speculative stocks to take the more assured, yet still historically high returns available in out-of-favor equities.

There is a lot of talk now about the New Economy (meaning Internet, technology and telecom). Certainly, the Internet is changing the world and the advances from biotechnology will be equally amazing. Technology and telecommunications bring us opportunities none of us have dreamed of.

“Avoid the Old Economy and invest in the New and forget about price,” proclaim the pundits. And in truth, that has been the way to invest over the last eighteen months.

As you have heard me say on many occasions, the key to Tiger’s success over the years has been a steady commitment to buying the best stocks and shorting the worst. In a rational environment, this strategy functions well. But in an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum, such logic, as we have learned, does not count for much.

The current technology, Internet and telecom craze, fueled by the performance desires of investors, money managers and even financial buyers, is unwittingly creating a Ponzi pyramid destined for collapse. The tragedy is, however, that the only way to generate short-term performance in the current environment is to buy these stocks. That makes the process self-perpetuating until the pyramid eventually collapses under its own excess. [Charles here. Sound familiar? Fear of trailing the benchmark has led managers to pile into the FAANGs.]

I have great faith though that, “this, too, will pass.” We have seen manic periods like this before and I remain confident that despite the current disfavor in which it is held, value investing remains the best course. There is just too much reward in certain mundane, Old Economy stocks to ignore. This is not the first time that value stocks have taken a licking. Many of the great value investors produced terrible returns from 1970 to 1975 and from 1980 to 1981 but then they came back in spades.

The difficulty is predicting when this change will occur and in this regard, I have no advantage. What I do know is that there is no point in subjecting our investors to risk in a market which I frankly do not understand. Consequently, after thorough consideration, I have decided to return all capital to our investors, effectively bringing down the curtain on the Tiger funds. We have already largely liquefied the portfolio and plan to return assets as outlined in the attached plan.

No one wishes more than I that I had taken this course earlier. Regardless, it has been an enjoyable and rewarding 20 years. The triumphs have by no means been totally diminished by the recent setbacks. Since inception, an investment in Tiger has grown 85-fold net of fees; more than three time the average of the S&P 500 and five-and-a-half times that of the Morgan Stanley Capital International World Index. The best part by far has been the opportunity to work closely with a unique cadre of co-workers and investors.

For every minute of it, the good times and the bad, the victories and the defeats, I speak for myself and a multitude of Tiger’s past and present who thank you from the bottom of our hearts.

Charles here. The more things change, the more they stay the same. Value will have its day in the sun again, and that day is likely here with the FAANGs finally starting to break down.

Had Robertson held on a little longer, he would have been vindicated and likely would have made a killing. Consider the outperformance of value over growth in the years between the tech bust and the Great Recession:

 

So, don’t abandon value investing just yet. If history is any guide, it’s set to leave growth in the dust.

 

 

This article first appeared on Sizemore Insights as Keeping Perspective: Julian Robertson’s Last Letter to Investors

Is the FAANG Trade Over?

I recently joined a roundtable discussion hosted by Investing.com. The questions posed: Is The FAANG Bull Run Over and are Tech Stocks Still A Buy?

This was my answer:

The FAANGs trade is a little long in the tooth at this point, and, frankly, no trade lasts forever. Apple (AAPL), Amazon (AMZN), and Alphabet (GOOG) were all within striking distance of trillion-dollar market capitalizations, and Facebook (FB) was on pace to get there pretty quickly at the rate its share price was appreciating. There is still a lot of like about this group. All are leaders in their respective corners and all but Netflix (NFLX) and Amazon have extremely fat margins and large cash cushions.

But in the race to $1 trillion, valuations have gotten stretched, and growth looks more questionable. Social media is no longer new (a third of the world’s population is already a regular Facebook user) and Facebook’s business model is now under regulatory scrutiny. Smartphones are a saturated market, and Apple’s business model depends heavily on squeezing more revenue out of a base that is no longer growing. Netflix faces new competition from former partners, such as Walt Disney Company (DIS). Alphabet is still essentially a one-trick pony that depends far too heavily on advertising revenues from its search engine. Amazon is attracting unwanted political attention, and any or all of these companies could be the subject of antitrust action by the U.S. or European Union.

These are all strong companies and it makes sense to keep them on a watch list. But I’m not a buyer at current prices and this late in the cycle. The better trade today is in beaten-down value sectors. I particular like midstream energy and auto stocks at current prices.

You can read the other answers here.

Disclosures: Long AAPL

This article first appeared on Sizemore Insights as Is the FAANG Trade Over?

Dividend Growth Portfolio 1st Quarter 2018 Letter to Investors

The first quarter of 2018 was not kind to value and income investors. Long-term bond yields started rising in the second half of last year, and that trend accelerated in January. For the quarter, the Dividend Growth portfolio lost 7.36% vs. a loss of 1.22% on the S&P 500. [Data as of 3/30/2018 as reported by Interactive Brokers. Past performance is not a guarantee of future results.]

Remember, as bond yields rise, bond prices fall, as do the prices of bond proxies such as utilities, REITs and other high-yielding stocks.

At the same time, the great “Trump Rally” that kicked off after the 2016 election reached a frenetic climax in December and January. The proverbial wall of worry that has characterized the “most hated bull market in history” since 2009 crumbled and was replaced by the fear of missing out, or “FOMO” in traderspeak.

The combination of a surge in bond yields and a sudden preference for high-risk/high-return speculation over slow-and-steady investment caused most income-focused sectors to underperform in January.

And then February happened. Volatility returned with a vengeance, dragging virtually everything down, growth and value alike. So, in effect, value and income sectors enjoyed none of the benefits of the January rally, yet still took a beating along with the broader market in February and March.

SectorBenchmarkQtr. Return
Large-Cap GrowthS&P 500 Growth1.58%
Large-Cap StocksS&P 500-1.22%
InternationalMSCI EAFE Index-2.19%
UtilitiesS&P 500 Utilities-3.30%
Large-Cap ValueS&P 500 Value-4.16%
Real Estate Investment TrustsS&P U.S. REIT Index-9.16%
Master Limited PartnershipsAlerian MLP Index-11.22

It’s striking to see the differences between sectors. Even after the selloff in the leading growth stocks — the “FAANGs” of Facebook, Amazon, Apple, Netflix and Google — the S&P 500 Growth Index still managed to finish the quarter with a 1.58% gain.

Meanwhile, the S&P 500 Value Index — which is a reasonable proxy for Sizemore Capital’s Dividend Growth Portfolio — was down 4.16%.

It actually gets worse from there. REITs and MLPs — two sectors in which Sizemore Capital had significant exposure at various times during the quarter — were down 9.16% and a staggering 11.22%, respectively.

Suffice it to say, if your mandate calls for investing in income-oriented sectors, 2018 has been a rough year.

I do, however, expect that to change. While I consider it very possible that we see a bona fide bear market this year, I expect investors to rotate out of the growth darlings that have led for years and into cheap, high-yielding value sectors that have been all but abandoned.

Why a Bear Market is a Real Possibility

They don’t ring a bell at the top. But often times, there are anecdotal clues that a market is topping.

As a case in point , my most conservative client — a gentleman so risk averse that even the possibility of a 10% peak-to-trough loss was anathema to him — informed me in January that he would be closing his accounts with me because I refused to aggressively buy tech stocks and Bitcoin on his behalf.

He wasn’t alone. Again, anecdotally, I noticed that several clients that had been extremely conservative since the 2009 bottom suddenly seemed to embrace risk in the second half of last year. The fear of missing out — FOMO — had its grip on them.

This is the first time I’ve seen FOMO in the wild since roughly 2006. I was working in Tampa at the time, and the Tampa Bay area happened to be one of the centers of the housing bubble. I recall watching a coworker buy a house she couldn’t quite afford because she was afraid that if she waited, prices would quickly get out of her reach. She and her husband bought the house as the market was topping, and it was a major financial setback for them.

It may be in bad taste to recount personal anecdotes like these, but I do for an important reason. I want to avoid falling into the same mental trap.

Today, the market is expensive by historical standards. The cyclically-adjusted price/earnings ratio — or CAPE — is sitting at levels first seen in the late stages of the 1990s tech bubble.

Meanwhile, we are now nearly a decade into an uninterrupted economic expansion, and we’re effectively fighting the Fed. Chairman Jerome Powell has made it very clear that he intends to raise interest rates fairly aggressively to nip any potential inflation in the bud.

None of this guarantees that the current stock correction will slide into a bear market. (The same basic conditions were true in the 1998 correction, and stocks went on to rally hard for another two years.)

But it does tell me that caution is warranted, and that now — more than ever — we should stick with financially-strong value and dividend stocks. In a turbulent market, I expect to see investors seek shelter in “boring” value stocks offering a consistent payout. In a market in which capital gains no longer appear to be the “sure thing” they were a year ago, a stable stream of dividend income is attractive.

Will Value Get Its Mojo Back?

Growth utterly destroyed value last quarter. But this is really just a continuation of the trend of the past five years.

Consider the five-year performance of the iShares S&P Value ETF (IVE) and the iShares S&P 500 Growth (IVW). Growth’s returns have literally doubled value’s, with most of the outperformance happening in 2017.

Growth massively outperformed value in the last five years of the 1990s. But this is by no means “normal” or something that should be expected to continue indefinitely. Consider the performance of the same two ETFs in the five years leading up to the 2008 meltdown.

Value stock returns didn’t quite  double their growth peers. But they outperformed by a solid 40%, and that’s not too shabby.

This by no means guarantees that value stocks will outperform or that the specific value stocks Sizemore Capital owns will outperform. But if the market regime really has shifted — and I believe that it has — then the “FAANGs” story is over. Investors will be searching for a new narrative, and I believe that value and income stocks will be a big part of that story.

In the first week of the second quarter, I moved to a moderately defensive posture, shifting about 20% of the portfolio to cash. This gives us plenty of dry powder to put to work once this correction or bear market runs its course. But if I’m wrong, and this is yet another buyable dip, then we still have substantial skin in the game.

And whether the market goes up, down or sideways, we’ll continue to collect a high and rising stream of dividend income.

Looking to a better second quarter,

Charles Lewis Sizemore, CFA

ETF Flow Portfolio 1st Quarter Letter to Investors

The ETF Flow Portfolio met its first real challenge in the first quarter of 2018, and I’m proud to say it passed with flying colors. The portfolio returned 2.99% for the quarter compared to a loss of 1.2% for the S&P 500. (Returns were net of trading costs but gross of management fees, which may vary by account size. As always, past performance no guarantee of future results.)

But what excites me the most isn’t the outperformance. It’s the fact that the outperformance was achieved by successfully side-stepping the major drawdowns in February and March. The S&P 500 was down 3.9% in February and 2.7% in March on a price basis. By comparison, ETF Flow was down 0.06% in February and up 0.46% in March.

By using its short-term momentum indicators, ETF Flow rotated into defensive positions and spent most of February and March in bonds and cash equivalents.

The stock market has arguably been the greatest wealth-creating machine in all of human history, and it allows passive investors to own a little piece of the world’s greatest companies. But that doesn’t mean that buying and holding an index fund is the best strategy at all times. Market valuations swing like slow-motion pendulums, gradually moving from underpriced to overpriced and back to underpriced again. Unfortunately, after nearly a decade of uninterrupted bull market, stock prices have swung towards being overvalued again. The cyclically-adjusted price/earnings ratio (“CAPE”), among other valuation metrics, suggests that stocks are priced to deliver flat or negative returns over the next decade.

At the same time, stocks investors are effectively fighting the Fed, as Chairman Jerome Powell is committed to gradually raising short-term rates and winding down the Fed’s balance sheet, which was inflated by years of quantitative easing.

Meanwhile, GDP growth and employment both look exceptionally strong at the moment, particularly compared to recent years. But these are lagging indicators that tend to be at their highest near the end of the economic cycle.

None of this is to say that expensive stocks can’t get more expensive or that the stock current correction is guaranteed to slide into a full-blown bear market. But it does suggest that it is prudent to maintain a nimbler trading strategy or, at the very least, to diversify into complementary, noncorrelated strategies. And this is precisely the role that ETF Flow successfully filled during this correction and the role that I expect it to fill going forward.

Looking forward to a strong 2018,

Charles Lewis Sizemore, CFA

Below you can view our most recent factsheet:

Do We Really Need More ETFs?

Tadas Viskanta continued his Blogger Wisdom series by asking “What ETF, if it were launched tomorrow, would you invest in with little (or no) hesitation? Said another way what asset class or strategy is not currently effectively available in an ETF wrapper?”

Here was my answer: “Frankly, there isn’t one. We arguably have a bubble in ETFs, indexing in general, and even in smart beta.”

I seem to be echoing the sentiments of several of the other contributors:

Robin Powell: “I’m quite happy with my family’s portfolio as it is. It would be refreshing to have a day without another ETF launch!”

Tom Brakke: “I have no idea. There are too many already. The industry machine is at work cranking them out.”

Cullen Roche: “Nothing. The ETF market is becoming saturated. Most of the new strategies are gimmicky nonsense being sold to people who think they need something they don’t.”

Michael Batnick: “Nothing. I’m content.”

I have to say though, Phil Huber’s tongue-in-cheek reply might have been my favorite:

While it may seem like there is nothing new under the sun in ETF land, there is one glaring hole when it comes to product development and that is an ETF that capitalizes on the most consistently accurate contrarian indicator known to mankind – Dennis Gartman.

The Inverse Gartman ETF (Proposed Ticker: WRNG) would provide investors a transparent, rules-based way to take the opposite bet of whatever Gartman is bullish or bearish on that week on CNBC.

Ouch.

Great replies, as always. To see the full list, see Finance blogger wisdom: missing ETFs

This article first appeared on Sizemore Insights as Do We Really Need More ETFs?

Finance Blogger Wisdom: What Did the Last Ten Year Teach Us?

Continuing his annual Finance Blogger Wisdom series, Tadas Viskanta of Absolute Returns asks: Ten years have passed since the onset of the financial crisis. What about the past decade has changed your thinking about the economy, financial markets or investing?

This was my answer:

Value investing works, but applying a value strategy without some kind of momentum filter is a recipe for frustration because cheap stocks can stay cheap for a long time in the absence of a catalyst. You don’t necessarily need to know the catalyst ahead of time. Simply waiting for a cheap stock to resume some kind of modest uptrend will save you a lot of grief. This has been a decade in which growth has absolutely thrashed value.

There were some really good answers by Tadas’ collection of bloggers. To read their answers as well, see Finance blogger wisdom: ten years in

This article first appeared on Sizemore Insights as Finance Blogger Wisdom: What Did the Last Ten Year Teach Us?