Picking the Right Pundit
High on the list of investor mistakes is chasing performance. Even though the top market pundits are aware of this fact, they make the same mistake — time after time.
Buying what worked last year is the easiest way to pick stocks, sectors, or managers. It is also the worst. Despite this, it is the key question that every new investor asks. It is natural. It seems relevant. For most investors it is the most obvious part of "due diligence."
When we are having a good year in stock picking, as we are now, it is easy to go with the flow. But it is not really what we recommend. Our long-term record — and that of others — should be the real question.
The False Litmus Test
We are in an era where CNBC introduces every bearish pundit with "He was one of the first to see the problems in the [housing, credit, CDS, derivative] market. There are no track records on those who missed some big gains by making very bearish predictions many years before the collapse. Taking the other side, people like Warren Buffett were well aware of the risks, maintained cash, but bought back into the market "too early."
We now have a bunch of rookies who think that Warren Buffett has "lost it." They also think that some perma-bear is a genius.
One of the big news stories of the day was the SEC filing from hedge fund manager John Paulson, noted for making big money by shorting financial stocks last year. When a major bear on a sector switches positions, that is news.
Today on RealMoney Jim Cramer observed "Buffett got this period wrong and we bid up anything he buys. Paulson got it right and we are supposed to ignore him."
Cramer repeatedly highlighted Regions Financial (RF) and also mentioned it in his regular "Stop Trading" spot on CNBC. The stock rallied after his early comments and popped eight cents again on high volume during the CNBC appearance.
Everyone noted that Paulson had a large position in Bank of America (BAC). Cramer felt that RF was the stronger play.
Our feeling is that both Paulson and Buffett deserve respect. There are many different methods that generate above market returns in different time frames. The facile emphasis on last year's pundits has already been a losing move for many investors. And please note that Cramer was not disparaging Buffett, but emphasizing Paulson.
Meanwhile, Felix Salmon (one of our featured sources) was highlighting a bearish Bloomberg article by Jonathan Weil, suggesting that the footnotes showed that Regions Financial was insolvent!
We can imagine investors selling the stock based upon Weil or Salmon, buying it based on Cramer, or being very confused after reading both.
Another Example
Tonight's Kudlow program had a segment with Elaine Garzarelli. The assembled punditry scoffs whenever she appears. Her great call on the '87 crash is an ancient memory, and most now dismiss her bottoms up method of evaluating stocks and sectors. We disagree.
Most pundits do not really consider her methods, which are actually quite good. She has a viewpoint that may well prove to be correct, flying in the face of the conventional wisdom of traders. Here were a few key points:
- Her 2010 S&P earnings estimates are $73 and she is looking for a multiple of 17.5. That corresponds to the pre-Lehman market of 1250 in the S&P 500.
- She sees the biggest threat to this valuation as an increase in risk spreads. Corporate bonds are an alternative to stocks.
- She also replied to Kudlow that more FASB efforts to impose unrealistic marks on existing holdings would be a big negative.
- She sees the downside for stocks as 4 to 7 percent, mostly based on normal fluctuations.
Our Take
The Garzarelli earnings estimates and multiple are actually quite reasonable given current interest rates and growth projections. The S&P at 1250 gets back to pre-Lehman levels. It is not "bubble land." That was at a time when the market expected a recession, but not a depression. It represents a good initial target for stocks. It is not an extreme target.
The declining risk spreads have increased the valuation for stocks. She is correct in noting that any increase in bond yields is the biggest risk for stock valuation.
Making a major investment in equities implies a significant reward/risk picture. This ratio of 5 or 6 to 1 is pretty attractive. The exact timing (September selling?) is a bit of a guess.
Full disclosure — We have a small position in BAC, a larger position in regional banks, and we are taking a serious look at RF.
There are no track records on those who missed some big gains by making very bearish predictions many years before the collapse.
What do you mean by “many”? Certainly someone perma-bearish since the late 80s/early 90s is just a “stopped clock” example. But the 2003-2007 market cycle is a different animal. The 2007-March 2009 bear cycle retraced ***ALL*** of the “gains” of the 2003-2007 cycle (most bear cycles leave a good chunk of the bull cycle gains intact).
What “big gains” were missed UNLESS ONE actually sold and did not ride equity positions all the way down. If a pundit was generally bullish from 2003-2007, especially 2006-2007 (which was tactically correct), unless that pundit specifically called to sell stocks/reduce equity exposure at some time during the bear market especially pre Oct 08 crash, then it really is very disingenuous to speak about bearish pundits “missing big gains”. It really is just a wash. The bullish pundits gave back all of the 03-07 move while the bearish pundits missed the upmove and the downmove recognizing that the entire 03-07 move was just a debt-induced reflation that was unsustainable.
Taking the other side, people like Warren Buffett were well aware of the risks, maintained cash, but bought back into the market “too early.”
We now have a bunch of rookies who think that Warren Buffett has “lost it.”
FWIW, Buffett missed out as well on the big gains in the 03-07 move. In his personal account, he was pretty much 100% cash and bonds during the entire 2003-2007 cycle according to reports, and even at Berkshire (which I own) he retained a very large cash position during most of the 03-07 move only deploying the cash hoard in the past 12 months or so.
The S&P at 1250 gets back to pre-Lehman levels. It is not “bubble land.” That was at a time when the market expected a recession, but not a depression. It represents a good initial target for stocks. It is not an extreme target.
Let’s say we get to 1250 in 2010 which I think actually is very achievable more so for technical and momentum reasons then actually a reasonable valuation based on actual sustainable economic fundamentals. What then? Does one continue to basically hold all existing equity exposure at that level or begin to reduce equity exposure to raise cash for potentially another late 2002/early 2003 and March 2009 type buying opportunity maybe in 2012. Perhaps I’m stating the obvious, but one can only buy cheap if they have previously sold high and have substantial cash to deploy. As the book from Don Cassidy states, “It’s when you sell that counts”.
Mike C –
I think I agree with your comment, if I understand it accurately. There are various approaches. Funds which were long-only have one result. Those recommending short positions have another.
Some trading types caught part of both moves.
One thing to consider, and which I am trying to highlight here, is that those “calling the crash” have some special wisdom.
In particular, you and I disagree about the inevitability of all of this, including the handling of Lehman, the treatment of distressed assets, and the insistence on mark-to-market accounting.
I am trying, as usual, to emphasize the need to look ahead.
Many long-only managers do not engage in market timing. Investors make their own decisions about where to invest, adjusting their commitment to reflect their opinions.
Having said this, we do sometimes lighten up based upon our indicators. We did this in 2000, but not last year.
We will soon see whether methods that made a loose multi-year bearish prediction represent strong methods for the next year or so.
Thanks for a typically insightful and provocative comment.
Jeff
I am trying, as usual, to emphasize the need to look ahead.
I absolutely agree, but I think to look ahead and get some sense of what is likely it is useful to try to ascertain what actually happened to precipitate the most severe recession and bear market in 70 years.
***IF*** the view is correct (which I think you hold) that this entire financial crisis and severity of recession was simply the result of a few policy mistakes such as Lehman, the treatment of distressed assets, and mark-to-market accounting, then I would *AGREE* that it largely follows that the right policies can get us right back to the “Old Normal” trajectory for economic and corporate profit growth, and that we could see $80-$100 in S&P 500 earnings perhaps much earlier then many expect with a move again to that 1500ish level in maybe a couple of years.
However, ***IF*** the view is correct that this is the inevitable result of an excessive buildup of aggregate debt over the previous 10-20 years, especially at the consumer level, and that all that other stuff was simply the match to get the combustion going, then it follows that we are in for many years of sub-par economic growth and corporate profitability (Mauldin’s “statistical” recovery) as the consumer deleverages and gradually goes from 70% to 60%.
But I would think to even start to potentially arrive at the right answers about multi-year predictions, one must start with asking the right questions about what drove growth and profitability during the last cycle?
Anyways, I do appreciate your perspective and sometimes I push a little hard to see what kind of push back I’ll get. Truth is arrived from vigorous debate, not everyone holding hands and cheerleading each other, and I push hard on other forums on the total gloomsters who think the S&P should be at 150 to 300 and that the U.S. economy is headed for the third world in the next 5-10 years.
Mike C — Pre-Lehman we were attempting to avert a recession, or keep it mild. I often wrote that a recession was normal, occurring every five or six years.
You have made this too much of a dichotomy. There were obviously problems in leverage at investment banks, regulating the CDS market, and making unsound loans that were rated AAA.
The way that we handled these problems had an element of the self-fulfilling prophecy. Assets of all types moved much lower in value. The frequently cited chart showing debt to GDP or the like is very misleading. It is chosen at a low point of the cycle and pays no attention to asset values.
If you plan to wait for debt values to get back to normal via savings and tax hikes, you should plan never again to invest in stocks. The gap will be closed the way it always has been — through income and revenue growth.
I hope that clarifies my thinking a bit, and thanks for the opportunity.
There is one part of your message — repeated by everyone — that I think is completely wrong. I’ll write a full piece at some point. Let me take an extreme example. Let us suppose that the Earth was hit by a meteor, causing death, disease, famine — whatever. Imagine your own scenario.
The problem now is to rebuild society. Would you turn to the experts on meteors? Those who failed to provide warning? Or might different expertise be relevant to looking forward?
I think the debate over causes of the financial meltdown is a question for historians. If you are going to wait for an answer before coming up with a financial plan, you will be too slow.
Maybe I need a better example than the meteor, and perhaps readers will help.
Thanks again,
Jeff
Rogoff says that the conventional post-mortem on Lehman is wishful thinking.
RB — I saw the column. Interesting analysis from a first-rate source.
Rogoff has a good public policy perspective, noting that some kind of failure was necessary to get any commitment for action.
I repeat that allowing Lehman to fail did not cause our problems. The handling of the crisis created secondary effects that were much larger than necessary. For example, there was a nearly complete cessation in commercial paper and other normal business lending. Businesses looked at this and started laying off people in accelerated fashion.
I’ll be interested in reading Rogoff’s book, getting a better look at the evidence for his viewpoint.
Thanks for the pointer!
Jeff
Jeff,
I’m sure you’ve seen this too but I suspect that the book discusses this paper in greater detail.
And oh, the air of Ken Fisher in his put-down of this paper .
Thanks again for more pointers — and good ones. I wonder if we can get our friend Mike C to look at this quote from Fisher:
The fact that the earnings yield (the inverse of the price/earnings ratio) of nonfinancial firms is today higher relative to long-term interest rates than it’s been in your adult lifetime is not reported either.
It is in stark contrast to the sources he cites here. They all look at trailing earnings and find some silly P/E ratio, or ignore interest rates (which no asset allocator in the real world would do).
I really appreciate the comments of you and Mike C. You highlight problems in my original thinking — poor explanations, omissions, and errors — that I should consider more carefully.
Thanks again.
Jeff
Thanks again for more pointers — and good ones. I wonder if we can get our friend Mike C to look at this quote from Fisher:
The fact that the earnings yield (the inverse of the price/earnings ratio) of nonfinancial firms is today higher relative to long-term interest rates than it’s been in your adult lifetime is not reported either.
It is in stark contrast to the sources he cites here. They all look at trailing earnings and find some silly P/E ratio, or ignore interest rates (which no asset allocator in the real world would do).
Jeff,
We’ve been over this ground before with respect to forward earnings yield relative to interest rates. I guess we’ll just have to agree to disagree.
I’ll simply note once again that the “Fed model” and its various versions had stocks as “cheap” prior to the worst bear market decline in 70 years while “silly” metrics like Shiller’s P/E (which really is just Ben Graham’s metric from Intelligent Investor) which uses 10-year trailing earnings correctly warned that stocks were in dangerous territory in 2006-2007.
Doug Kass was on CNBC. Absolutely phenonemal interview. Just amazing.
http://www.ritholtz.com/blog/2009/08/playing-both-sides-of-the-market/
He whipped out this quote:
“The best lack all conviction, while the worst are full of passionate intensity. William Butler Yeats.”
I don’t have much conviction here bullish or bearish. There are very good arguments both ways. Valuation is basically fair, technicals look really bullish to me, and maybe we can get a sustained recovery without the consumer.
Kass made a point that hit me like a sledgehammer. He said we were in a time when it is best to lose opportunity rather then lose capital. I think I’ll continue to hedge both ways with reasonable equity exposure (I own Berkshire, Fairholme Fund and some other stuff) and a substantial cash position.
Back to the Fisher quote. Firstly, I still believe there is a very good possibility we are living in time when you need to go back beyond “our adult lifetimes” to draw the most appropriate comparisons. I am somewhat reassured that in the video Kass seems to be on the same page that you have to go back to the 30s and a similar debt bubble and unwinding to really understand the dynamics at play and thus what might be appropriate valuations in the “New Normal”
When you have time, you should really read this paper which is written by someone who also is a professor and CFA. I could be wrong on this point, but my sense is you might not spend time on material against your own confirmation bias (your quick easy dismissal of Rosenberg was a tell on this).
http://www.ritholtz.com/blog/2009/08/active-value-investing/
An excerpt:
Now as I promised, let’s take a look at the role interest rates and inflation play in market cycles.
As I mentioned before, my thoughts on the role of interest rates and inflation have changed since the book came out. The historical data on the relationship between inflation, interest rates, and market cycles (P/Es) is not conclusive. The 1960-2006 period shows a very tight relationship between P/Es and interest rates, but the 1900-1966 period shows that was absolutely no relationship between market cycles (P/Es) and interest rates – none. Also, what happened in Japan over the last 15 years throws another wrench into the P/E and interest rate debacle. Despite a decline of interest rates to almost zero, Nikkei stocks have declined and P/Es contracted.
I have a theory that explains the role that interest rates play in stock market cycles.
Now I think your position would be the 1900-1966 time frame is completely irrelevant. You may be right. But that is a belief. It is something that can’t be proven statistically or logically deduced.
So do you go with the 1960-2006 data which is what Fisher is doing “adult lifetime” or do you go even further back? to the 1900-1966 data. My own view (and I could be wrong, I don’t have passionate intensity in it) is you have to look at the question in the context of the economic supercycle of debt buildup and deleveraging which means you have to go back to before 1960.
Time will tell. I would think though that after the 2007-2009 bear market you would be a little less dismissive of silly P/E ratios that did the job in warning there was no margin of safety in buying the S&P at 1400-1500. Many of those same silly P/E ratios also were indicating stocks were undervalued at 666-700, although not mind-blowing cheap like 1974 or 1982.
RB,
Thanks for the Rogoff link. Interesting read.
Uggghhh…I screwed up the formatting on my first post. If it isn’t clear, the paragraph starting with “Now I think your position” is where my writing starts again and the article excerpt ends.