“The riskiest thing in the investment world is the belief that there’s no risk.”
Howard Marks, Oaktree Capital
I think most of you will agree with the old saying that “you are what you eat.” Just look around the world at wealth levels of societies and their locals. A broad generalization is that those societies who are wealthier are heavier, with the generalized exception of those coastal populations who tend to eat a healthier diet of fish. In the investment world, it could be said that you are what you read, although this is also a broad generalization complete with much background noise. In Howard Marks’ latest newsletter, he writes quite frankly about investment cycles, past and present, investor psychology and behavior, again past and present, and lastly, the importance of risk and the prudence of controlling investment risk. Cycles do happen in investing where you can almost compare bull and bear markets to daylight and dark. The last dark cycle was so deep that many stock investors have been afraid to come back into the market, at least until now. The S & P 500 is up over 100% above its low in early 2009, and only now do individuals show a renewed interest in buying equities. Many see the return of the individual investor as the beginning of the end of this cycle; certainly it is a sign of a heightened appetite for risk assets. There are also other signs, such as Bank of America’s roll-out of an aggressive new mortgage lending program, and the much increased use of leverage in private equity deal making. While large capitalization stocks are still fairly priced, some mid-cap and small-cap indices have already hit all-time highs. Don’t get me wrong, I like a bull party as much as anyone, but as Marks writes, a time for caution may be in order.
As the signs crop up for a little more risk control in the stock markets, the bond markets are way ahead of their equity brethren in terms of being at high risk levels. The U.S. Federal Reserve Bank, along with most other central banks around the western world, has kept a low interest rate policy for four years now. They have “forced” fixed income investors farther out on the risk curve looking for better yields. I get the feeling that many of the these investors understand the inherent risk they are taking in reaching for higher yields, but feel they have been forced into participating in Bernanke’s strategy of recreating wealth through risk assets. Paul Volcker, back in the early 1980’s, had a similarly mammoth task of fighting runaway inflation, certainly different than the deflation problem Bernanke has tackled. But in both cases, there was a growing budget deficit caused by tax cuts and high Congressional spending. Volcker created much pain by putting the U.S. economy into recession by raising interest rates above 15%, but he did something else just as important. After inflation began to moderate, he held rates relatively high, forcing Congress to focus on the growing federal deficit because the country couldn’t afford to pay those high rates of interest. It worked and the U.S. economy enjoyed an unparalleled period of prosperity from 1984 through the late 1990’s. One can only hope our current officials read Volcker’s new biography.
Many of you know we have a preference for using small mutual funds where the owners of the fund have a substantial stake of their own money at risk. In other words, they are “eating their own cooking.” Our experience is that these funds tend to have very focused, high performing management teams. The downside of this strategy is they also tend to close the funds sooner than later, knowing that they cannot effectively deploy huge influxes of cash. So it is with our emerging markets selection; representatives of the Virtus Emerging Markets Opportunity Fund called us about two weeks ago saying the fund would close at the end of January. The next day, Morningstar named the manager, Ravi Jain, international mutual fund manager of the year. We have enjoyed and hopefully will continue to enjoy our relationship with Ravi and his team, but primarily because, as Howard Marks preaches, he has factored risk control into his methodology. Congratulations to him, and continued thanks to you for your ongoing confidence in the people of Longview.
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