July 11, 2014 | by Justin Capetola
Hardly a day passes without another market guru predicting an imminent 10% or greater drop in the U.S. equity markets. Take for example the June 30th Yahoo article “Common Sense Says Look Out for a Market Drop.” Yet, in the face of much worry and skepticism coming from the various news outlets, the equity markets continue their move up. General Motors has recalled 28.5 million vehicles in the first half of 2014, which is more vehicles than it sold from 2011 through 2013, yet its stock has hardly reacted. Oil prices have risen 9% since the beginning of the year with little effect on the market. The Dow is up approximately 2.7% this year and the S&P 500 up approximately 7.1% this year. The old cliché “sell in May and go away” has thus far gone unfulfilled. Eventually the markets will suffer a 10% correction and like a monkey throwing darts there will be a guru who happened to pick the correct day to make their prediction (it probably won’t be their first time calling for a correction). The problem is what about the hundreds who have been wrong, in some cases multiple times, over the past 5 years? Many large pension plans, university endowments, and others wish they had stayed the course rather than reallocate to alternative investments. Take for example the Harvard University endowment, once considered one of the best run endowments in the world. The five year return for the Harvard University endowment fund has been a scant 1.7% per year through June 30, 2013. Interestingly enough, Jack Meyer managed the endowment from 1990 to September 30, 2005, beginning with an endowment worth $4.8 billion and ending with a value of $25.9 billion (including new contributions). During the last decade of his tenure, the endowment earned an annualized return of 15.9% and was a major investor in closed-end funds. Mohamed El-Erian succeeded Meyer and pledged to “rebuild and reinvent” the endowment. Though Mohamed El-Erian is long gone, changing the investment strategy has not been kind to the endowment.
Predicting market movements has never been easy and is the primary reason that a long-term approach is necessary when investing. There have been many reasons to expect a market correction this year, among them a spike in crude prices (in effect a tax on consumers); a first quarter GDP return of a negative 2.9%; Fed projections of rising interest rates; a reduction in bond purchases by the Fed; second quarter downward projections of GDP growth by many economists; runaway government spending paired with runaway government debt; underfunded pension plans; a cooling housing market; potential inflation (certainly a reality for most consumers); a drop in consumer spending and confidence; lack of trust in our politicians, to name a few.
So, what is an investor to do? The uptrend is still intact and quoting another old cliché which warns “never fight the Fed.” We closely watch the Fed’s comments as rising interest rates will certainly cool and possibly reverse the upward trajectory of the market. As a value investor, we are constantly looking for ways to improve the risk versus return of our portfolios. Many of these strategies have been covered in previous newsletters. Currently, we still see some value in the U.S. market and advocate employing hedging techniques in an attempt to reduce risk when the often predicted correction finally occurs. For the appropriate client, we also see value in foreign markets both developed and emerging. Emerging markets carry a P/E of approximately 10.3x versus 18.5x for our domestic indices. Many closed- end funds continue to be attractive with some of the old-line names offering discounts to Net Asset Value of 12-15%. Every investor is different, and no one investment program is ideal for everyone, but for the past 40 years the value approach we follow has provided a reliable investment solution. Please let us know of any change in your investment profile or any concerns you may have concerning your portfolio. We welcome visits from our clients and look forward to speaking with you again shortly.