Evidence Based Investing

“Once a barrel of lit matches rolls into a field of dynamite sticks, you don’t try to predict which one will explode; you just get the heck out of there”- John Hussman (US Portfolio Manager). Sterling’s immolation has taken centre stage again this week, but behind the scenes, after a long lull, problems in Europe are starting to re-appear. Both political and economic issues, long avoided, have come home to roost, putting the prospect of full-scale crisis back on the agenda. Let us count the ways…

The hypocrisy of some is that we like to think of ourselves as sophisticated and evolved, but we’re still also driven by primal urges like greed and power- Michael Leunig (Australian Cartoonist and Poet). [This posting serves as an adjunct to the latest Wendy Cook article, posted on Tuesday, regarding Structured CD’s in the US. What follows is a more UK-centric version of same].—Last week an adviser asked me about a new Structured Product a client had shown him. My first reaction was to rubbish it. However, I felt duty-bound to delve deeper into it. What I found made me wonder whether I had under-reacted! What I want to show today is not only how bad these sorts of things are for Investors, but how these firms make money on them (at the investor’s expense). Indeed, given access to these markets, investors could actually construct these products for themselves.

“Stocks have reached what looks like a permanently high plateau.” – Irving Fisher, (economist), 3 days before the 1929 market crash. We have covered this subject before (here, and in our Quarterly Review of Q2 2015), but it is always worth returning to, as Investors appear unable to shake off the conviction that they can “beat” the market. Passive inflows (and Active outflows) suggest the tide is turning, but as all politicians feel obliged to say nowadays, there is still much to do. It is gratifying to know that the ranks of Index investors are rising (through EBI, but others too), and that we are no longer the geeks at the party that no-one wants to talk to.

“The Fed is now hostage to Wall Street. If the stock market pulls back a few percent the Fed becomes frightened. In a way I suppose, the Fed is justified in that belief because it is responsible to a great degree for the elevation of financial asset values”. Jim Grant (Grant’s Interest Rate Observer). On Friday, Janet Yellen, the Head of the US Federal Reserve, will speak at their annual Jackson Hole Conference, (in Wyoming), and is widely expected to comment on US Interest Rate policy. With an election in November, September may be the last chance to raise rates before the traditional pre-election purdah, as the Fed tries to maintain the illusion of political neutrality. But will they take it? Opinion is divided on the subject, despite what some Fed officials say.

“All markets look liquid during the bubble (massive uptrend), but it’s the liquidity after the bubble ends that matters.” J. Schwager, Market Wizards. Anyone who is looking at Global Investing is now (post Brexit) having to confront the currency issue. To hedge or not to hedge? Let’s see if we can make any sense of the issue…The purpose of hedging currency risk is to isolate returns on the asset class from that of the currency in which they are denominated. It is vital to ensure that asset returns are not overwhelmed by adverse currency movements. The charts below show the Implied Volatility for the (U.S.) Bond and Equity markets respectively (both are annualised figures).

Wendell: [Viewing the desert crime scene] It’s a mess, ain’t it, Sheriff?Ed Tom Bell: If it ain’t, it’ll do till the mess gets here. from No Country for Old Men (2007)

“Following the British referendum to exit the European Union, the paper value of global assets briefly fell by about $3 trillion. This decline in the market capitalisation immediately garnered headlines, suggesting that some destruction of “value” had occurred. No. The value of a security is embodied in the future stream of cash flows that will actually be delivered into the hands of investors over time. What occurred here was a paper loss” John Hussman, weekly comment, 4/7/16.