Forecasting the stock market is never an easy task. The principle behind a bull market are simple enough: if valuations are attractive, liquidity is plentiful and the earnings outlook is favorable, then it is reasonable to expect the market to rise. In practice though, it is not always that simple.
Archive for the ‘Asset Allocation’ Category
Principle versus Practice: Forecasting the Market
Friday, February 5th, 2010The Covert Analytics Trinity
Saturday, January 30th, 2010These are three integral components of the Covert Analytics approach, what we call our Trinity!
Here is a description of these components:
Gut feeling: We believe that the best money managers have a certain amount of experience, that translates into a “gut feeling” of the market. A deeper sense as to what drives the market’s up and down moves that does not vacillate depending on what the headlines say is causing markets to gyrate. It always amuses us when we see Bloomberg headlines that explain that “the market is up today because of X” and then subsequent day to see the market down and to have a headline that reads “X continues to disappoint, thus leading the market lower”. Gut feeling allows you to over write the noise. It allows you to have a grasp of what the market is going to do, how you will react if it unfolds and how you will manage your risk if it does not.
Systematic approach: This term refers to having a disciplined approach to investing, usually applied to ‘systematic hedge funds’. A systematic hedge fund is a concept that explains the investment style of the fund, where a system is in place to trade markets irregardless of the hedge fund manager’s input. The opposite of this is a discretionary approach, ie one where the hedge fund manager makes all investment calls for the fund on an “ad hoc basis”. We do not advocate that any investment advisor adopt a black box style approach to investing, which is what the majority of systematic hedge funds employ. What we strongly advocate however is that having a systematic approach which helps you maintain a framework across booms and busts, across bull markets and bear markets, will help you achieve greater returns over the long run by avoiding common pitfalls of investor emotions.
Global macro focus: Again this is a hedge fund term, but really applies more on the markets traded than anything else. The best global macro hedge fund managers (Paul Tudor Jones of Tudor Investment Corp, or Bruce Kovner of Caxton Associates) make the majority of their investment calls on broad market moves (ie where is the S&P going, how Crude, Gold is going to trade, where the Euro is headed) and typically abstain from “I like Dell over Microsoft” type calls. It is an emphasis on global capital flows and making money on stock, bond and commodity markets across the world. They benefit from the fact that usually “there is a bull market somewhere”. So not only is this a regional de-emphasis (ie go global), it is a security type definition as well (broad market indexes).
Covert Analytics is a software platform that was developed to allow investment advisors combine these three key paradigms into one successful money management platform. Our asset allocation software was designed to allow you to combine your gut feeling, with a systematic approach (that you custom tailor), and to have a global macro focus (rather than just simply allocating to US stocks, US bonds, and Cash).
The Covert Analytics Team
US Stock Market Outlook
Wednesday, January 27th, 2010The S&P 500 today had a shakeout in response to the Federal Reserve announcement. It has since made a great rally (not shown on the graph!!!).
S&P 500 Intraday
Regardless of the noise today – please note the 5% correction we have had over the past two weeks. This coincided with earnings season. It is interesting that 3/4 of the companies that have reported earnings beat estimates, according to Bloomberg. If you look at an average 4Q earnings report, it is typical to see a 8-10% increase in revenue y-o-y but a nearly 20% gain in earnings. Shows that companies are being run very efficiently; Gavekal says they are being run even more efficiently than sovereigns!
- S&P 500 Intraday for past 15 days
The trend from March 2009 seems still well in place. It is clear the pace of stock gains has moderated since about November, and we are having another 5 % selloff. In the graph below there are arrows indicating the 5% corrections that have occurred since the rally began. In other words, no need to cry wolf yet. Markets are trading reasonably well and we believe they are in great shape. In other words, any further weakness in the broad market would be seen as a short term buying opportunity for those investors who have not entered or have a lower than target allocation.
S7P 500 past 12 months
On a similar note, we acknowledge the many tailwinds that are facing investors … they include ( this is a non exclusive list compiled by us ):
And the case for the bulls is as follows:
Bulls ...
Great chart by PIMCO: “Ring of Fire”
Tuesday, January 26th, 2010There is no need to throw out another rambling dialogue over indebtedness and the sovereign risk that is or is not priced into markets. Regardless, this chart shows an interesting “Venn Diagram” of the groupings of nations as measured by their deficit (as a percent of GDP) plotted against their federal indebtedness. We have discussed in recent posts Japan, and the nearly 200% of GDP tsunamai of debt they have hanging over their heads. But PIMCO intelligently groups Japan and some Western nations into a Ring of Fire.
These include: US, UK, Spain, France, Italy, Ireland, Greece and Japan:
PIMCO: Ring of Fire
The general justification for the fiscal deficits central banks have run were that it was necessary at the time, and that the private sector would eventually replace the government’s money. PIMCO put it this way:
“the global private sector is now expected by some to detox and resume a normal cyclical schedule where animal spirits and the willingness to take risk move front and center.”
That has yet to take shape. We have long felt that what what will turn this recovery into a “sustainable” economic recovery will be if this return of animal spirits ensues. PIMCO says the following:
“But there is a problem. While corporations may be heading in that direction due to steep yield curves and government check writing that have partially repaired their balance sheets, their consumer customers remain fully levered and undercapitalized with little hope of escaping rehab as long as unemployment and underemployment remain at 10-20% levels worldwide.”
PIMCO then goes on to discuss Reinhart / Rogoff who put together a seminal study called “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”. Link is included below. We saw Carmen Reinhart speak at the Inter American Development Bank presentation in Miami a few years ago. She is a stunning academic, with forceful thoughts and words to be heeded. Her study almost implied that over the long run, no governments pay off their debt! Very interesting read, and though long I strongly suggest you read it.
The important point to remember about the historical analysis of financial crises is that “the starting point is important”. The following table shows the gross level of public and private debt (measured as a percent of GDP). The results are impressive - and scary considering the precarious situation of the US, UK and Japan.
Total Debt as a % of GDP
The next chart shows the total indebtedness (as a group) of advanced (red) versus developing (blue) countries. One can see why the emerging markets escaped from the financial crisis relatively unscathed. Their financial markets performance was another story.
Developed versus Developing
Bill Gross and PIMCO continue to put out their monthly Investment Outlook for free. It is available to the worldwide financial community, giving you rare, FREE, access to one of the preeminent thinkers on investment strategy.
Great quote from a NY hedgie
Wednesday, January 20th, 2010Was speaking to a NY based event driven hedge fund manager yesterday, and he had a great quote:
“Investing is 70% instinct, and 30% homework”
This is no small time hedgie either. He is the founding partner of a $2 billion event driven hedge fund. Reminds us of a great quote from one of our favorite investors, Marc Faber:
“Investing has a lot to do with common sense and personal observations”
We built Covert Analytics to allow investment advisors and portfolio managers to input their views across global capital markets. The framework we initially conceptualized would allow investors to apply a logical methodology to evaluate a varied group of assets, and to see how this methodology would have worked historically.
Here is how we see our platform “mixing” with our great quote:
Your views, our platform
Covert Analytics is a platform, that combined with your views, produces information that helps drive your portfolio management process
Our plaftorm + Your Views = Input for your PM Process
Our platform is not a black box which tells you how to allocate. Our software allows you to input market specific views without the traditional academic mumbo jumbo of forecasting market returns or standard deviations, but instead allows you to build and combine indicators which are consistent with your views. Our proprietary backtest methodology allows you to evaluate how your asset allocation model performs historically, factoring in the portfolio guidelines you set forth, and proposes a recommended asset allocation.
Covert Analytics is a platform which allows you to build dynamic, quantitative asset allocation models that are driven by your expertise, and your views. We are glad our hedgie friend said that, because we could not have agreed more!
The Covert Analytics Team
Start asking the right questions
Friday, January 15th, 2010As an investment advisor you are primarily responsible for 1) having a view on the markets and 2) how to position your portfolios (given their unique constraints) according to those views. Too often more attention is paid to the vehicles used to implement those decisions. In other words, rather than spending the bulk of your time deciding how much to allocate to Equities, you spend the bulk of your time picking Equity fund managers.
The article below is a perfect example of this. Though it is a good article, from the Financial Times Fund Management section, it should not be groundbreaking news to investment advisors. It should be met with a shrug of the shoulders.
The wrong question still has a good answer!
Too often outperforming Equity managers still cost portfolios to suffer substantial drawdowns in a bear market. Too often the best bond fund outperforms its benchmark by 300 bps annually during a market cycle that saw Equities double. You see where this is going? Start asking the right questions:
In general, here is our view …
How we view market risk
Friday, January 8th, 2010Risk is alot like rain, and your asset allocation is alot like an umbrella. Your portfolio (you) always seem to get wet on your feet and the bottom part of your legs, right? Thats because the part of your body most exposed to the rain is your “risk assets” such as Equities and Commodities. These are the more volatile assets which though they have the best chance of giving your portfolio a substantial boost are also the most exposed when “the bear comes a-knocking”. The dry, upper part of your body? Thats the Bonds and Cash in your portfolio. Much more protected from the rain and thus less susceptible to market swings.
Risk and the Umbrella
Covert Analytics aims to be your bigger umbrella!
Covert Analytics = less risk
Trends in the Investment Management Industry: ETFs
Tuesday, January 5th, 2010This graph is a depiction of how the investment management industry has evolved since the 1980s. Whats most obvious is that the dominance held by traditional funds (ie mutual funds) is being replaced by the index funds or passive investment approach. Also note the growing importance of alternatives. By alternatives we mean the alternative invesmtment management industry (specifically hedge funds, private equity etc). Under index funds we lump the growing asset classes devoted to commodities (including Crude, Gold, Silver, Agriculturals, etc).
Evolution of the Asset Management Industry
We think most investment advisors should abandon the desire to bringing the “best” in the investment management industry into their client portfolios. Time after time, we have seen mutual fund managers with stellar “alpha” capability get destroyed on a absolute and relative basis (Bill Miller of Legg Mason and Richard Pzena of the Pzena Value Fund are some examples). What about hedge funds? They never do any harm right? Wrong. Forgetting for a moment the obvious disasters like Madoff, there have been a string of “high-flying, hot shot” hedge fund managers that blew up rather spectacularly.
Some “meltdowns” to note of in the hedge fund world: Polygon Global, Platinum Grove, and Amaranth … which were forced to wind down after horrendous performance. A slew of other hedge fund disasters are “restructuring” their funds, something which to me sounds like changing around the terms so they can start charging egregious performance fees given they are years away from hitting their old “high water marks”.
Regardless, the range of investment options via low cost index funds is growing at a steady rate. For those eager to implement asset allocation strategies across various stages of the business cycle, futures or index funds are the way to go.
The Covert Analytics Team
What is investing?
Monday, January 4th, 2010Here is our take on investing (borrowed from an analogy of Mr. Buffett): laying out cash in the present to get more cash in the future.
Diagram of What Investing Means
Aesop explained a relevant principle in one of his famous fables:
Aesop's Fable
Aesop was saying that it is better to have a sure thing than take a major gamble. Applying this concept to investing:
Aesop's Theory on Investing
Investing is trading the bird in the hand today for more birds in the future. There are many questions to ask including how many birds are in the bush, how sure you are to catch them, when you will catch them and how many birds there are in other bushes.
Our Approach: A better way to money management
Monday, December 21st, 2009Portfolio management is not just about asset allocation and matching your tactical approach to the client’s investment objectives. It is also about a range of other issues: existing relationships your clients have (with private bankers, fund managers, etc), existing “legacy positions” and how to unwind them, allocation to illiquid holdings, security selection, etc. Our approach has always been to advocate that portfolio managers maintain as much control as possible over portfolio holdings, and the top down allocation decision. The more intermediaries there are, the less control the portfolio manager has.
Intermediaries come in many shapes and colors: alternative managers such as hedge funds and private equity shops, private bankers with typically expensive fee structures and a penchant for selling structured notes (a low risk way to collect a nice fee without doing much work), mutual funds that have great “track records” that mysteriously fizzle out as soon as you invest with them. Our response: why risk it? Your clients entrust you with their money. Your job is to protect capital. The more control you have, the higher your chances at doing just that. Diversification out to intermediaries may seem like an appropriate way to diversify risk. But in the end, it simply complicates your life because now in addition to having to worry about markets and how to position portfolios, you have just added a slew of other variables you must now track: managers tracking error, operational risk, private equity sub company holdings, etc etc.
We love global, liquid, capital markets. Why entrust your money to a Private Equity manager that makes a killing off your client’s hard earned capital for them to sit back in a comfortable Manhattan office and allow an army of employees to make a living doing the groundwork. We suggest you cut the fat. Why worry about your mutual fund manager’s stock picking ability when in a declining equity market, 200 bps of outperformance still could mean a decline of -25%! You see why our emphasis is on global (because opportunities in investing are NOT limited to the US), and liquid (because why risk illiquidity when more often than not the vehicles to get access to illiquid assets are way too costly) capital markets.
