Myopia, It's Not Just Your Eyes

February 2018

Way too many investors talk a good game about being in it for the long-haul, then repeatedly thwart themselves and their portfolios by piling into hot investments and paying too much attention to short-term market swings. Though market pullbacks are very common, and bubbles can go undetected for a time, two of the biggest drivers of short-term thinking are the impact of conditioning and the influence of the echo chamber.

Conditioning Fosters Shortsightedness

Investors have been conditioned to put too much weight on short-term market events by the media, industry analysts, investment managers, and companies themselves. Wall Street analysts make news for the accuracy of their short-term earnings estimates, while relying on regular guidance from company managements. Companies, under pressure from their boards, large investors, and analysts to meet estimates, report financial results and host earnings calls on a quarterly basis. And the financial media breathlessly covers each stock price wobble. It doesn't help that investors’ fund statements arrive on a quarterly cycle regardless of the nature of their investment accounts or their time horizon. All of this contributes to an environment where investment managers and funds are viewed as only as good as their last quarter’s performance.

The Echo Chamber, Where Objects Appear Larger (And More Important) Than They Really Are

Susan Cain’s book, “Quiet: The Power of Introverts In a World Where No One Can Stop Talking," isn’t about investing. Yet the last few words in the title are a good description of the 24-hour news cycle. The steady drumbeat of background noise — some meaningful, much meaningless — including blow-by-blow analysis of very short-term news flow and price moves in financial markets magnifies their impact. With all the self-reinforcing factors arrayed against long-term thinking, it's no surprise people wind up being nudged to make short-term moves at odds with both a carefully thought-out investment strategy and their long-term goals. Caught up in all the hype, investors can let their emotional reactions make them look more like speculators. 

Nearsightedness And Your Portfolio

What’s the (predictable) result of this myopia? Hyped up by a fear of missing out and the desire to avoid losses, investors sometimes abandon their strategies in order to follow the herd. They might try to time the market by piling into hot sectors and stocks or jumping out of investments that have recently lagged. Cashing out and waiting on the sidelines for the storm to pass is another reaction. Does any of this sound familiar?

The problem with these emotionally-driven responses is that markets are generally efficient, making it impossible to consistently time them. Instead, by jumping in and out, investors increase their chances of missing rallies, which tend to closely follow market drops. So they wind up selling low and buying high. This can really hurt your portfolio, damaging your chances of hitting long-term goals. And constantly churning your portfolio eats into returns: costing you in fees and trading commissions. You’re also likely to pay more in taxes because of the higher capital gains tax rates on short-term investments (those held for less than a year). All these effects compound over time.

Being stoic when faced with an onslaught of seemingly important news, data points, and reporting is not exactly realistic, or even possible for most of us. But it is possible to resist the pressure to act, detaching emotional reactions from your investment actions, by remembering you are likely to do yourself more harm than good by trying to chase returns or avoid losses. Staying calm is also critically important to ultimate investing success — a long game that plays out over time and market cycles.

Cryptoconnery? Be Wary of Cryptocurrencies Bearing Gifts

January 2018

One could (almost) be forgiven for thinking that staying on the sidelines as prices for Bitcoin and other crypto currencies surge is not rational. But that would mean not only suspending healthy skepticism, but also risking being left holding the proverbial bag when the cryptocurrency bubble deflates. Below are three reasons not to let fear of missing out push you into a rash decision.

Source: Coinbase

Why You Should Apply Some Common Sense to the Cryptocurrency Hype

No intrinsic value. So-called crypto currencies are neither legal tendernor do they meet the definition of money. Namely, they are not stores of value or mediums of exchange. Fed Chair Janet Yellen once referred to Bitcoin as “a payment innovation,” while the Commodity Futures Trading Commission (CFTC) views it as a commodity and the IRS considers it property. And, unlike precious metals —here’s looking at you gold— cryptocurrencies have no intrinsic value. 

Limited transparency. Three of the most appealing aspects of blockchain, the distributed ledger technology underlying Bitcoin and other cryptocurrencies such as Ripple and Ether, are the ability to transact without intermediaries (and the fees they impose), greater anonymity (in the most extreme libertarian desires, from the taxman), and more security versus prevailing systems. Yet those benefits come with tradeoffs. 

The other side of the coin, so to speak, is a higher risk of fraud. As it is, there have been a number of widely covered instances of theft of Bitcoin and outright cons. Which leads me to my third point.

Few safeguards. In December of 2017, the Chicago Board Options Exchange (CBOE) allowed Bitcoin futures contracts to start trading on its exchange. Trading on Nasdaq is set to begin later this year. Despite, that, global regulators are still trying to figure out appropriate regulatory frameworks even as markets and investors race ahead. 

All of this makes cryptocurrencies and related financial securities vulnerable to dramatic price moves whether from sudden swings in sentiment, trading  disruptions (glitches, outages, and collapsing exchanges ), or news of the latest heist. Meanwhile, regulatory action that dramatically alters the current Wild West free-for-all, changing the calculus of winners and losers, is an ever-present risk.

But I Still Want Exposure to the Crytocurrency Space…

So if rushing to invest in the latest initial coin offering (ICO) doesn't make sense, what should investors, as opposed to speculators, do? Whatever Bitcoin, Ether, and Ripple's eventual fate, blockchain itself shows promise. Blockchain-based applications include payments and legal transactions, medical records storage, property titling, and managing digital identity, to name just a handful. It makes sense for those seeking exposure to look to existing companies that stand to benefit from those applications, and that already generate cash flows, have earnings, operations, and managements that can be scrutinized. For now, this is a wiser strategy than rushing headlong into an emerging, largely unregulated sector rife with minefields.

Where Should Fixed Income Investors Look for Yield?

December 2017

Despite widespread concerns markets will react poorly to higher interest rates, there are a number of attractive investment opportunities for global bond investors willing to do their homework in assessing the balance of risks versus rewards.

After an extended period of maintaining extraordinarily low interest rates, the U.S. Fed has begun normalizing rates. In addition to its string of interest rate increases during 2017, the Fed announced plans to unwind its balance sheet holdings of Treasury and mortgage-backed securities (purchased as part of its post-financial crisis quantitative easing policy). Amid concern the end of the prolonged (credit) party is fast approaching, investors and market analysts are now assessing which areas of fixed income might perform well in a rising rate environment. Below are two that present attractive opportunities and one worth watching.

One fixed income sector that should perform well as interest rates rise in the U.S. is emerging markets debt. Not only are the economies that make up this broad investment category performing well when assessed on fundamentals (GDP growth rates, current account balances, debt levels, and overall credit profiles), some areas of concern have diminished over the past year. Investor sentiment has turned less cautious on bellwethers Brazil and China as prices for major commodities such as oil and copper recovered during this year’s second half, Brazil has so far weathered a widespread government corruption scandal, and China’s leaders took steps to begin reining in the worst of the country’s financial sector credit excesses.

To Market, To Market

Emerging markets performance in 2017 reflected these positive trends with strong investor demand/inflows. Emerging market economies are also benefitting from higher growth rates—in the mid-single digits according to International Monetary Fund 2017 projections —versus rates of 2.1% for the Eurozone and 2.2% for the U.S. Political risk is certainly higher than in the West, particularly given upcoming elections in a number of emerging markets countries including Brazil, Russia, Argentina, and Mexico. Additionally, credit pressures continue in China’s banking sector. However,  yield and spread differentials versus the Barclays Aggregate —5.5% versus 2.7% as of December 6, 2017 (WSJ as sourced from: S&P Dow Jones Indices; Merrill Lynch; Barclays Capital; J.P. Morgan) —coupled with a near to intermediate term investing environment outlook that appears largely benign, suggest this as an attractive trade.

One caveat to this positive scenario would be efforts by the Trump administration to implement policies supportive of its pre-election protectionist tough talk on trade. Given the multitude of issues pre-occupying the administration and Congress though, including the overhang of the ongoing investigation into potential pre-election collusion with Russia, all against a backdrop of 2018’s upcoming Congressional midterm elections, we see this possibility as low risk for now.

Searching High And Lo(ans)

Leveraged floating-rate loans represent another area of the fixed income market with continuing value. The asset class offers the benefits of senior ranking in issuers’ capital structure, secured status, and interest rates that are pegged to LIBOR. As interest rates rise, coupon payments on the loans reset higher. From a pricing and yield perspective, the asset class compares favorably with bonds. The S&P/LSTA Leveraged Loan Index traded close to par, at $98.32, as of December 6, 2017, and had generated YTD returns of 3.1%. That compared favorably with the Barclays Aggregate's YTD return of 3.5% as of the same date. 

Market technicals including record CLO issuance of more than $100 billion in 2017 should continue to bolster trading levels. Despite rising recently, default rates remain below 2% and are expected to rise only gradually over the near to intermediate term. Adding further comfort, given the debt's secured nature, loan recoveries post default have historically been significantly higher than those for bonds.

Don't Forget TIPS

Lastly, while not especially compelling buys in the short-term, over the intermediate term, Treasury Inflation-Protected Securities (TIPS) could be worth a modest allocation. While inflation has so far remained well below the Fed’s 2% target rate despite the strengthening economy, signs of a pickup, particularly if unexpected, could lead to increased interest in TIPS as a hedge. One catalyst could come from passage of the GOP's tax cut package. 

The Joint Committee on Taxation (JCT) projects a revenue loss to the Treasury of roughly $1.4 trillion over ten years. Meanwhile, economists are split on the legislation’s impact on economic growth rates. According to Bloomberg News, a survey of economists in November revealed 20% estimate no impact on growth from the planned tax cuts, while about half expected a positive impact of 0.2% to just under 0.4%. The JCT estimates the bill would add 0.8% to GDP growth. 

A sustained upward move in inflation figures closer to the 2% level the Fed views as its upward limit, whether stemming from stimulative effects of the tax bill, a continued rise in the consumer price index (which recently has surprised to the upside), or growing wage pressures could see demand for TIPS increase given their contractually-guaranteed inflation protection.