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Thomas J. Feeney's Measure of Value offers periodic commentary on leading financial issues of the day. Additionally, we present occasional articles explaining the philosophical underpinnings of the investment approach that our firms have employed successfully since 1986. Our thinking frequently differs from the common wisdom of the investment industry. The investment approaches we employ always recognize this as a probability business, not a certainty business. In evaluating any investment action, we always weigh the potential damage should the market prove us wrong.

While we have great respect for investment history, we recognize that each era introduces unprecedented specifics. In all that we do, we attempt to identify value, in both a relative and absolute sense. History has demonstrated that long run investment performance leaders need not be the leaders in bull markets as long as they avoid giving up significant portions of their assets during bear markets.

We firmly believe that one need not be fully invested at all times. In fact, we far prefer to assume relatively large levels of risk when assets are historically cheap and to be heavily risk-averse when assets are historically expensive. This approach has proven successful for our clients over more than a quarter century.


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No Blog Today


April 11, 2014

Working on the quarterly commentary.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Another Debt Milestone


April 4, 2014

 

4-4 Editorial Pic Smaller

Source: Lisa Benson, Washington Post Writers Group

Switzerland-based Bank for International Settlements recently announced that global debt passed the dubious $100 trillion milestone in mid-2013.  That’s almost twice the mid-2013 $53.8 trillion world equity value.  In the six years since mid-2007, just before the financial crisis, equities declined in value by more than 6.5% while debt levels exploded by 42% from $70 trillion to $100 trillion. The prime causes were governments piling on the debt to rescue economies from recession and corporate treasurers taking advantage of record low interest rates.

With the U.S. and Japan promising to add far more debt to central bank balance sheets this year and Mario Draghi pledging to “do whatever it takes” to lift the Eurozone’s stagnant economy, debt levels will inevitably march higher.  Most major equity markets have risen appreciably since 2009, confirming investor belief that growing debt is certainly no roadblock to higher stock prices.  Those, in fact, who point to debt levels as a danger are frequently ridiculed for repeatedly crying wolf.  True, excessive leverage has been offered as a reason for caution for a decade and a half, yet many equity markets are near all-time highs.  It’s perhaps worth recalling, however, that in 2008 excessive debt levels necessitated an unprecedented central bank bailout to prevent a collapse of the world banking system.  Greece, Portugal, Ireland and Cyprus were essentially bankrupt without restructuring or coordinated rescue efforts.  In this country, Detroit is a recent example of debts having risen to unserviceable levels.

Rising stock prices, declining interest rates in financially stressed countries, and silver-tongued central bankers seem to have eliminated fear in most investors.  It is irrational, however, to ignore centuries of history that testify to the damage done to economies from debt relative to GDP even far lower than that prevalent today throughout most of the developed world.

Central bank efforts to shore up bank capital levels have certainly succeeded to a degree.  Leverage in the U.S. has been roughly cut in half from pre-crisis levels.  That many assets are not yet marked to market, however, argues that our banks are not yet in the clear.  On top of that, many have again begun to issue large amounts of the covenant-lite loans that became all too common leading up to the 2008 crisis.

A recent Morningstar report demonstrates that, despite deleveraging, major European and Japanese banks are just now getting down to leverage levels in the mid-twenties, where U.S. banks were just before the 2008 crisis hit.

Not only is the quantity of debt worrisome, quality is as well.  On April 2, Financial Times reported that Europe’s banks hold more sovereign debt than at any time since the Euro crisis.  Because Basel II rules allow regulators to treat sovereign debt as risk free, banks do not have to hold any capital against it.  When the European Central Bank gave banks the opportunity to borrow at 1%, many invested the loan proceeds in the higher yielding sovereign debt of countries like Spain, Italy and Portugal, all of which had and still have precarious finances.  These countries and their banking systems are dangerously intertwined.

Not having experienced many countries or major banks going unrescued, today’s investors have become overly complacent.  Excessive debt levels are a real danger.  In a recent International Monetary Fund working paper, Carmen Reinhart and Ken Rogoff offered a cautionary historical precedent.  There was a widespread default on World War I debts to the United States by both advanced and emerging nations.  Those debts were never repaid.  In today’s extremely leveraged environment, a similar outcome is not out of the question.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Janet Yellen held her first press conference as Chair of the Federal Reserve Board Wednesday. She promised to continue to penalize the elderly retired and others who are income dependent.

The Fed having now kept short-term interest rates at the zero bound since 2008, Janet reassured bankers that they can count on free money at least into next year and very possibly longer.  By the way, Seniors, you can count on no return from risk-free investments.  That wasn’t enough, however.  Janet also pledged to keep trying to push inflation up, which will assure that the things you have to buy will cost more.  Lest you think that push might at least give you Seniors a shot at higher income, Janet said: “Not so fast.”  Even after inflation gets to 2% or more, she promised to help bankers by keeping rates near zero for a “considerable period of time.”  Sorry, Seniors.

Perhaps you could get a little yield if you did what the Fed has been trying to “force” you to do (their word).  However, because longer interest rates have risen since late-2011, if you made bond purchases in that period of time, you’ve probably lost money despite the Fed’s best efforts to keep bond prices elevated.  If longer rates continue to rise, which is the Fed’s forecast, bond holdings could lose money for years.  Maybe that’s not a great idea for Seniors who likely will never be able to replace lost capital.

Instead, Seniors might want to ramp up the risk level even higher by adding equities to their portfolios.  After all, the Fed has admitted that one of the purposes of its ultra-stimulative monetary policy is to boost asset prices to create a positive “wealth effect.”  It certainly has succeeded in boosting stock prices to the point at which they are today overbought, overvalued and overloved.  It’s an open question whether Seniors should count on a continuation of that positive effect as the Fed tapers and ultimately ends extraordinary stimulus.

Almost all analysts with a knowledge of history anticipate that the Fed’s explosive debt creation will end badly, but there’s no timetable for such an outcome.  As long as investors’ faith in central bankers remains strong, the good times can continue to roll.  How many Seniors will have the foresight to step away before stock prices experience significant damage?  Will the Fed soon lose control of equity prices as they have lost control of longer interest rates over the past two years?

If the Fed’s historic monetary experiment ultimately fails, not only will Seniors have been deprived of income for much of their retirement, they may also have been prodded to lose their capital.  Talk about unintended consequences.  Thanks, Janet.

On a far happier note, for those of a similar persuasion, Go Cats!

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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This week I had the pleasure of meeting with the CEO of a socially important not-for-profit organization. Our conversation turned to dramatic changes in the investment markets in recent years, especially since 2008, when central banks began history’s greatest monetary experiment to pull the world’s banking system back from the edge of collapse.

The gist of our conversation was that investment consultants, investment committees and others charged with sculpting investment policies and strategies for not-for-profit organizations were unwittingly putting such organizations directly in harm’s way by doing business as they have been trained. Our analysis applies equally to retirees or other individuals with largely irreplaceable capital.

Investors who have learned their craft in the past four decades–including a growing cadre of CFAs–have become firm believers in the wisdom of a buy and hold strategy and in the importance of structuring a proper asset allocation to match the risk-bearing capacity of the client. Underlying those beliefs are some fundamental assumptions, born of experience:

1) Don’t worry excessively about bear markets; stocks will always come back;
2) Fixed income securities provide a valuable offset to the volatility and risk of equities;
3) Except to meet liquidity needs, cash is trash.

Admittedly, if allowed a multi-decade time frame, the first two assumptions usually prove true. And in most years, stocks and bonds outperform short-term cash equivalents. But there are noteworthy exceptions to these generalizations, and history proves that very few individuals and not-for-profit organizations have the patience necessary to wait out lengthy negative disruptions.

After a five-year, stimulus-fueled stock market rally, investors evidence little fear of surrendering much of their profit. Such confidence is typical when extended rallies have been largely uninterrupted by significant declines. By many measures of investor sentiment, today’s investors are more enthusiastic about stock ownership than at any point in more than 100 years, except at the height of the turn of the century dot com mania that was followed by a devastating 50% stock market collapse. The accompanying table shows the destruction done to years of profits from major stock market declines that all began at even lower peaks of positive investor sentiment.

Table

When markets fell from earlier peak levels of investor confidence, gains earned in the prior 10 to 18 years were erased. Recovering to former stock market highs took from 9 to 25 years during the twentieth century. With unprecedented Federal Reserve assistance, the recovery took only 4 years from the 2009 market trough, which partially accounts for today’s great investor enthusiasm. Should markets fall from the current level of euphoria, it would be highly unlikely that the Fed would be able to provide similar stimulus.

A worst case scenario unfolded in Japan, where the stock market peaked at about 39,000 on the last trading day of 1989. At that time, the Japanese stock market was the largest in the world, and many believed that Japan had discovered the new industrial paradigm. Belief was strong that this would be a one-way market for years to come. While that turned out to be true, the direction surprisingly was down. In a series of lengthy contractions interspersed with rallies, prices fell to below 7,000 in 2009. Even after more than doubling to today’s 15,000 level, the index is still more than 60% below its peak and rests at a level first reached in 1986. Past performance and powerful investor confidence clearly do not guarantee even respectable future performance.

In the past, proper diversification and a prudent asset allocation have at least provided some portfolio support when stocks have been weak. Today’s investors, however, may not be able to count on traditional support from non-equity securities. Despite interest rates having risen for the better part of the last year and a half, rates are not far above historic lows. There is precious little yield on any but the riskiest bonds. When rates fell to near present levels more than 70 years ago, that marked the kickoff of a four-decade long rising interest rate cycle that lasted into the early 1980s. Over a period of more than 40 years, reasonably diversified bond portfolios failed to keep pace with inflation. Even unmanaged cash equivalents outperformed virtually all bond portfolios over that four-decade span. Having just experienced the exact opposite fixed income environment, with rates falling for three decades until mid-2012, few of today’s investors and consultants have experience of multi-year unproductive, even counterproductive fixed income portfolios. If we have seen the beginning of the next rising interest rate cycle, bonds may not only NOT protect portfolios during weak stock market cycles, they may contribute losses, as they did in 2013.

The fact that 1) the U.S. stock market is at historically high valuations accompanied by extreme investor enthusiasm and 2) interest rates are near all-time lows offer reasons why stocks and bonds could be in danger of turning down. Alone, the specter of possible bear markets would not persuade most prudent investors to shy away from traditional diversified asset allocations. There is, however, a far larger concern that should give serious pause to any investor unable to replace lost capital.

We are in the middle of the greatest monetary experiment in history. To rescue the banking system and the broader economy from forecasted collapse, the Federal Reserve Bank and major central banks across the globe have flooded the world with new money. By 2008, over its then 95-year history, the Federal Reserve had acquired debt on its balance sheet of about $800 billion. To stem the financial crisis, the Fed has exploded its balance sheet almost five fold to about $4.5 trillion, with more to come. As Dallas Fed President Richard Fisher has warned, the Fed has no realistic plan to unwind this massive debt burden. Past experience with far smaller amounts in other countries is hardly reassuring. In This Time Is Different, Carmen Reinhart and Ken Rogoff provide copious detail about hundreds of financial crises around the world over the past 800 years. While details understandably differ from episode to episode, some clear conclusions emerge. Governments almost invariably attempt to inflate their way out of debt crises. Occasionally, severe inflation unfolds. In almost all cases, economic growth is markedly stunted for a decade or two before economic normalcy can be restored.

Relative to the size of our economy, the U.S. has reached debt levels at which major problems have unfolded in other countries over the years. And we’re not alone. Extreme levels of debt-to-GDP are now typical in most developed countries.

So far, soothing words and promises from central bankers have maintained investor confidence throughout most of the world. But such confidence could shift quickly. Notwithstanding the success of central bank stimulus in boosting stock and bond prices, there has been a far smaller increase in broader economic growth. Many critics of the effectiveness of aggressive monetary stimulus–including some from within the Fed–are arguing for the rapid ending of quantitative easing. It is not at all apparent that the economy and markets can resume historically normal function without such artificial government support.

When assessing potential risks, former St. Louis Fed President William Poole’s admonitions should not be ignored. He famously contended that when you look at the numbers, the U.S. is only a matter of years behind Greece, which has survived economically only by the grace of its European rescuers. Should debt levels overwhelm the U.S., there is no rescue net big enough.

The above stated concerns are not forecasts; they are statements of realistic possibilities based on the lessons of history. No one knows how the future will ultimately play out. Some investors, however, are better situated than others are, should worst cases materialize. Those least able to recover from severely negative market environments, especially if consequences persist for a decade or more, may have to forego some significant potential for profit in strong markets to protect against unacceptable losses in the weakest markets, which unfortunately materialize from time to time over the decades. For years, we have urged strongly that investors build flexibility into investment programs in place of the traditional relatively fixed asset allocation approach. The latter will backfire badly if the central bank monetary experiment fails and equity markets fall into a lengthy decline, especially if that equity decline were accompanied by rising interest rates.

Very few of today’s consultants and investment committee members have significant professional experience of long lasting weak stock or bond markets, the last of which ended in the early 1980s. As a result, their beliefs have been profoundly influenced by three decades of favorable or at least rapidly recovering markets. An understanding of longer history argues for a more circumspect policy approach by those that cannot easily replace lost capital.

Unfortunately, the common approach to investing today is well characterized by the words of Chuck Prince, former head of Citibank, in explaining the bank’s commitment to risk assumption. Acknowledging, in the middle of the past decade, that financial commitments then being made would likely end badly, Prince infamously said that you had to keep dancing as long as the music is playing. The sad lesson, as in the game of musical chairs, is that not everyone gets a safe seat when the music stops. In fact, decades of history demonstrate clearly that the best and brightest in the world’s biggest financial firms are almost invariably wrong at every major market top. Should we descend into another lengthy bear market, they won’t ring a bell in advance, nor will even the brightest consultants and investment committee members urge greater restraint before the top.

CEOs, CFOs and other senior members of not-for-profits have an additional consideration. Consultants and investment committee members typically cycle in and cycle out, most providing best efforts while there. Should their counsel to structure a traditional investment program result in debilitating losses in a worst case environment, they will eventually move on. It’s the top officers and long-term members of non-profits who will bear the stigma of having presided over the loss of effectiveness of that organization’s mission if the ability to function as desired is compromised. Unfortunately that scenario has played out in decades past just at the time when weakened economies have placed the greatest demands on social service agencies.

Because it’s uncommon to build significant flexibility into portfolios, finding consultants or investment managers with a proven expertise in providing such service is not easy. In the current environment with the overhanging threat of possible failure of history’s greatest monetary experiment, prudence suggests that a more intensive search should be worth the effort.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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With the S&P 500 index having recorded a -3.6% return this January, newspapers and other financial publications have trotted out their “January Effect” stories. Such stories, with minor variations, follow the theme that “As goes January, so goes the year.” Not surprisingly, that’s not always true.

Using data from the Ned Davis Research Group, since 1950 the S&P 500 index has declined 25 times in January. Excluding 2014, the index has been down in 13 of those calendar years that began with a negative January. If we exclude the effect of January itself, the index has declined from February through year-end in 11 of the 24 years. As a predictor of market direction, the January Effect is not much better than a coin flip. Since markets rise in most years, however, it might provide benefit by simply raising investors’ level of caution. When January has been positive, the index has averaged a 12% return over the subsequent 11 months. When January has seen the index decline, the S&P 500 has been effectively flat for the rest of the year.

Of course, averages can’t tell us what will happen in 2014. While the following 11 months after a negative January have substantially underperformed those with a positive first month, there have been a few significant exceptions: +29.9% in 2003 and +35.0% in 2009. Those were both years in which the Federal Reserve Board was actively stimulating the economy and markets to pull the country out of recession and away from major stock market troughs.

In 2014 the Fed announced its intention to continue its aggressive stimulus, while gradually reducing the amount of its new money creation as the year progresses. We are left to discern whether the effects of stimulus will have the same positive effects as in 2003 or 2009, or whether the air comes out of the balloon with investors losing confidence in central bankers’ ability to control economic and market outcomes. It promises to be an exciting year.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Warning Flag Waving


February 3, 2014

It’s easy to vent against excess speculation. On the flip side, most in the investment industry deplore excessive regulation. Honest observers recognize clearly, however, that with implicit guarantees against failure, giant investors have aggressively assumed increasing levels of risk the farther away they move from the 2008 financial crisis. In order to continue such behavior, they have lobbied–largely successfully–to prevent potentially damaging incursions onto their turf by such forces as Dodd-Frank and the Volcker Rule.

Last Wednesday, Greg Roumeliotis reported on Reuters that the Office of the Comptroller of the Currency “…has already told banks to avoid some of the riskiest junk loans to companies, but is alarmed that banks may still do such deals by sharing some of the risk with asset managers…. Among the investors in alternative asset managers are pension funds that have funding issues of their own.”

It’s a longstanding truism on Wall Street that the longer a bull market persists, the junkier the deals that come to market. In the current zero interest rate environment, orchestrated by the Fed and other central bankers, the quest for yield is venturing into increasingly dangerous territory.

U.S. leveraged loan issuance hit a record $1.14 trillion in 2013, up 72% from 2012, according to Thomson Reuters Loan Pricing Corp. And the riskiness of these loans has simultaneously risen year over year, reaching the highest level of debt to EBITDA since 2007, preceding the economic collapse and 57% stock market crash.

Because regulators’ efforts are more readily designed to limit excessive risk-taking by banks, there are potentially greater levels of systemic risk in the shadow banking sector, including such non-bank financing sources as hedge funds, private equity funds and money market funds. As they did in the early years of this century, these entities are stretching for return in the highest risk deals and frequently levering them up imprudently. The last crisis unfolded when many such deals imploded.

When left to their own devices, as bull markets get long in the tooth, investors lose fear and stretch for return, and Wall Street is ever ready to meet such demand with increasingly suspicious product. Such behavior recurs in cycle after cycle and is a compelling reminder that lessons of the past are readily discarded as we travel farther from the most recent financial crisis. Current behavior is certainly waving a warning flag.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Today’s investors face extremely problematic decisions. Risk-free options provide essentially no return. Traditional low-risk investments in fixed income securities have produced losses for the past year and a half. Common stocks have surged higher with only minimal interruptions for nearly five years. Ignoring equity risk has not only been the best approach since 2009, it has been spectacularly rewarded. But the risks have not disappeared; they have been successfully papered over. Apparently off most investors’ radar, they have risen exponentially.

According to the Federal Reserve, the picture won’t be improving soon for those who desire a return on risk-free investments. The Fed’s “forward guidance” indicates no intention to raise short-term interest rates for many quarters at the very least.

Notwithstanding the Fed’s best efforts, longer-term interest rates have risen substantially, with the ten-year U. S. Treasury yield doubling from July 2012 to present. As a result, long maturity Treasury bonds experienced double-digit losses in 2013. The Fed’s policy of financial repression, with an avowed purpose of forcing investors to forego safety and assume risk, led many into bonds or bond funds in the latter years of the past decade. When rates were declining with the Fed buying vast quantities of Treasury and mortgage-backed securities, those bond purchases proved profitable, leading an ever-increasing number of investors to seek such Fed-supported returns. That strategy worked until it stopped working. By the time rates reached historic lows in mid-2012, the number of bond investors reached all-time highs, just in time to participate in the bond losses accrued over the past 17 months, despite continued Fed bond buying. Should interest rates continue to rise over the quarters and years ahead (which is the Fed’s forecast), an increasing number of bondholders will be saddled with losses. Following the Fed’s suggested paths can sometimes be hazardous to your wealth, especially when the Fed attempts to distort normal interest rate or valuation boundaries.

Fed stimulus efforts continue to support stock prices, however. So far, investors who have trusted in the Fed’s support have profited handsomely. To the extent that would-be equity investors have let valuations or sub-par fundamental conditions dampen enthusiasm for stock ownership, they have missed profit opportunities.

The question facing investors today is whether or not to trust the Fed to keep the party rolling. Despite slumping stock prices both domestically and around the world in the early weeks of 2014, historically reliable technical indicators suggest that it’s likely this equity rally hasn’t breathed its last. The persistence of positive price movement, favorable advance/decline figures, far more volume going into advancing than declining stocks and Lowry’s buying power and selling pressure data all point to stock prices likely having at least months to go before finding a ceiling to this already 58 month-long rally. On the other hand, many measures of investor sentiment closely resemble their levels in 2000 and 2007, immediately preceding stocks’ losing half or more of their values twice so far in this still young century. Stocks are clearly overbought, overvalued and overbelieved. Speculative margin debt has exceeded even its prior 2000 and 2007 peaks. With money essentially free, stocks are doing what real estate did in the middle of the last decade, and which led to the biggest real estate crash in modern times.

It remains to be seen whether or not stocks are ultimately fated to travel a similar path following misguided Federal Reserve interventions.

It has been almost universally acknowledged–even by Fed supporters–that the elevation of asset prices has occurred with only minimal benefit to the broader economy. Just five years ago, the multiplication of the Fed’s balance sheet from $800 billion to today’s $4 trillion–with more to come–would have been inconceivable. That increase in debt in the pursuit of higher stock and house prices has prompted surprisingly little outrage. By contrast, I have condemned it repeatedly, and have heard not one credible plan for the ultimate reduction of that debt level. The vast majority of analysts, strategists and commentators simply ignore it.

In a December 2013 International Monetary Fund Working Paper, Carmen Reinhart and Ken Rogoff warned of the potential folly of such complacency. They chastised advanced country central bankers and other policymakers for their apparent belief that first world countries will escape the consequences of massive debt levels that regularly occur in overindebted emerging countries. Reinhart and Rogoff state: “The magnitude of the overall debt problem facing advanced economies today is difficult to overstate… and the current level of central government debt in advanced economies is approaching a two-century high-water mark.” They argue from considerable historic precedent that advanced countries are likely to have to resort to some or all of the same approaches to emerge from massive debt levels that emerging countries regularly employ. Those approaches include: debt restructuring or conversions, financial repression and significant inflation (all forms of default), affecting debtors and creditors alike. The authors make the point that history argues strongly that the potential for major countries to simply grow their way out of today’s debt levels is minimal. If and when such events occur, the potential consequences to the world economy and markets are severe.

With history arguing strongly that unprecedented debt levels are likely to lead to multiple instances of debt default around the world, holding substantial permanent equity positions is a high-risk proposition. Mission has instead chosen to employ a strategic equity allocation approach based on a time-tested reading of dozens of fundamental and technical data points. Over the past 33 years, this process has provided an average return about 400 basis points above that of the S & P 500 with fewer and smaller losses than that index has experienced. In 2013 this strategy provided a double-digit return with a mere 37% exposure to equity risk. With monumental overhanging debt uncertainty, we strongly believe a proven strategic equity allocation approach to be far more prudent than a sizeable permanent equity position.

Thomas J. Feeney
Managing Director
Chief Investment Officer
January 21, 2014

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Year-End Valuation Update


January 3, 2014

The traditional year-end parade of investment analysts and strategists has been painting a rosy picture for 2014. A frequent argument emphasizes that a powerful up year such as 2013 is typically followed by another positive year, albeit one with a far more moderate return. Positive momentum could, of course, produce such a result.

At the same time, honest skeptics have reason to question whether central bankers will remain willing and able to continue unprecedented stimulus and, if so, whether such aggressive policy will remain effective in supporting equity prices.

Those of us who believe that valuations ultimately determine stock prices invariably sneak a peek at numerous measures of value. After having just received a year-end collection of valuation graphs from the outstanding Ned Davis Research data gatherers, now is a perfect time to evaluate market prices relative to historic valuation criteria.

While few analysts and strategists currently categorize market prices as “cheap”, most consider them “reasonable.” Very few, however, discuss valuation measures other than price-to-earnings. Chart 1 shows the S&P 500 selling at 19.1 times its trailing GAAP earnings. To put the current level into a clear historical context, we have drawn a solid line from the present level left across the entire date spectrum.

Chart 1 (Click on chart to enlarge.)
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While high, today’s 19.1 reading is obviously far below the peaks recorded so far in the twenty-first century. Observing that precedent, many commentators suggest that multiples could climb even higher before the current rally runs its course. It’s instructive to recall, however, that investors have rarely made money when purchasing stocks at or above the current PE multiple. Such purchases in the past two major market rallies preceded the two biggest stock market collapses since the 1929 crash and the Great Depression that followed.

If we consider today’s PE multiple relative to all cycles preceding the late-1990s, the current level is obviously high, typically exceeded only marginally near prior stock market peaks.

A look at other important measures illustrates that the market is, in fact, significantly overvalued. Chart 2 and Chart 3 demonstrate that price-to dividend and price-to-book value ratios never came even close to current levels before recent bubble readings.

Chart 2 (Click on chart to enlarge.)
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Chart 3 (Click on chart to enlarge.)
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The market crashes that began in 1929 and 1973—two of the worst of the twentieth century–each began at far less egregiously stretched multiples.

Chart 4 and Chart 5 paint the same picture with respect to price-to-sales and price-to-cash flow.

Chart 4 (Click on chart to enlarge.)
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Chart 5 (Click on chart to enlarge.)
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While these charts are current only through the third quarter and only go back to the 1950s, the message is nonetheless compelling. Almost certainly the multiples will be even higher when fourth quarter data are included.

While valuations are excellent long-term guides, they leave a lot to be desired as short-term market price forecasters. It is, of course, wise not to forget the old saying that markets can remain irrational longer than you can stay solvent.

While markets very rarely adjust instantly to any historic mean, it can be a helpful exercise to see where markets would be if they were currently at their long-term average levels. Doing a rough calculation of how much above average each valuation measure is today, it would take a 34% decline to just above 1200 for the S&P to reach its “normal” valuations. That level was first attained in late 1998 and, in the current rally, in March 2010. Prices are above that level today because valuations have risen far above normal.

We cannot know how long investor confidence will justify valuations remaining far above average. Next year we could again be celebrating a succession of stock market highs. On the other hand, there is a genuine risk that valuation measures could revert to or below long-term norms. The prime determinant probably remains central bankers’ ability to keep investors confident that they know what they’re doing and are capable of effectively carrying out their policy. The year 2013 demonstrated clearly the upside while that confidence prevailed. From today’s prices, reaching mean valuation levels would create great investor distress should that confidence wane.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Academics Rule the World


December 20, 2013

With the Federal Reserve prominently in the news again this week, having finally begun to reduce the amount of monthly stimulus, a few thoughts continue to nag at me. I offer the following for your consideration.

Having lectured over the decades at several nationally reputed colleges and universities, I have a very special place in my heart for men and women who dedicate themselves to educating subsequent generations. Most are very intelligent and extremely well informed in the areas of their specialty. A great many for-profit and not-for-profit organizations call upon such academicians for counsel as consultants and, in some instances, as board members. Imagine, however, a good sized corporation having a board of directors composed almost entirely of academics with virtually no direct business experience. That doesn’t happen. Imagine further that it were a giant corporation like GE, Microsoft, Wal-Mart or IBM. Inconceivable! How about an entity many times bigger than any of those that has a direct effect on virtually the entire world economy? That entity is the Federal Reserve.

While I have spent no time studying the curricula vitae of the Fed’s current board of governors, I have heard references to business experience only about Dallas Fed President Richard Fisher, who had prior hedge fund involvement. Several members have served in regulatory roles, but that’s far removed from hands-on business experience. How could we have arrived at the point at which we allow academicians, regardless of how intelligent, to function as world financial central planners? World business leaders have been remarkably silent about the need to interpose some practical business experience.

I can only presume that such silence stems from not having their ox gored in recent years. For the past decade and a half or more, the Fed has done little but let the good times roll. And what corporate CEO doesn’t like free flowing money? In the past five years in which the Fed has created more than 3 trillion new dollars and has usurped far more power than was ever expressly granted to it, corporate leaders have had no cause but to celebrate.

We can only hope that common sense will soon prevail and that a huge public outcry will arise against a small cadre of academics holding the reins of the world economy. The rationale for such an outcry becomes all the more obvious when we consider Boston Fed President Eric Rosengren’s recent description of current Fed policy as “experimental”, “trial and error”, and “learn by doing”. And he’s a supporter. This condition would be comical in the extreme if it were not so horrifically scary.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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Two Important News Items


December 13, 2013

Because of travel, this was a short week in the office. Nonetheless, a couple of news items deserve highlighting.

With stock prices on many major domestic indexes just off all-time highs, investor enthusiasm has grown stronger and stronger. The Investor Intelligence Advisor Service shows the highest percentage of bulls since the 2007 top that preceded a 57% decline in the S&P 500. The percentage of bears is now the lowest since 1987, just before the market’s 35% crash. The Daily Sentiment Index registered two 93% bullish readings in late-November, the highest in two years. According to The Elliot Wave Financial Forecast: “The only equal or higher readings since the peak of 2007 were single extremes of 93% bulls in February 2011 and 94% in November 2010. In the peak year of 2000, the only comparable extreme was also a lone 93% bullish reading on August 31, 2000…,” virtually the stepping-off point for the second market collapse of the still young 21st century.

Mission’s 2-Mode and 3-Mode equity allocation processes pay considerable attention to investor sentiment. These extreme sentiment readings are a clear negative in those quantitative formulas, currently offsetting other more bullish readings in such areas as money supply and price momentum, thereby leaving the formulas in a neutral zone.

A second news item worthy of note was Time’s naming Pope Francis its Person of the Year. While any pope has a bully pulpit to some degree, this week’s recognition is an acknowledgement that this pope is heard more widely than most, at least in modern times. I have no idea of Pope Francis’s level of financial sophistication; I suspect it’s relatively limited. Nonetheless, he is speaking out on economic matters, and the response he has elicited is testimony to the fact that his message is being heard. His admonition of today’s capitalism for its tendency to accentuate the gap between rich and poor may or may not be an insightful commentary on a system that has created great wealth and progress, much of which has benefited the poor, albeit in far lesser degrees.

As readers of this blog know, I have argued strongly against the super-loose monetary policies of the Federal Reserve. I contend that it is an immoral policy that is stealing from savers–most particularly from retirees–to benefit bankers and the wealthiest 1% of our society that owns a major portion of the assets whose prices are being elevated. The resultant debt burden that will be transferred to future generations will affect rich and poor alike with a financial encumbrance they had no voice in approving.

The relatively small voice of the opposition has clearly not deterred Fed actions. And while the pope is hardly directing his commentary to the Fed, we can hope that his voice will stimulate Fed Governors to consider more carefully the deleterious effects of their choice of winners and losers.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.




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