The Summary Investing Newsletter Issue 21 September 2014 London, England Lars Christian Haugen Contact: [email protected] In this newsletter I summarize other investing newsletters, articles, interviews and opinions by respected investors, in addition to adding some personal analysis. The aim is to provide the reader with a short and succinct guide to current investing opportunities. Disclaimer Under no circumstance is this an offer to buy or sell the securities mentioned in this newsletter. The author may or may not have bought the securities mentioned. Your decision to invest is your own and the author is in no way responsible for any loss you may incur. This newsletter is for informational purposes only. How much steam is left in the market? It is an interesting world we live in today. The volatility index (VIX index), also known as the “fear gauge”, is at the rock bottom level of 12. A reading this low can indicate complacency in the market, i.e. that investors are not expecting a lot of volatility going forward. A sentiment this positive can indicate there might not be a lot of upside left in the market, but that the downside risks can be substantial. However, a low VIX reading is not necessarily an indication that something bad is about to happen. In the decade leading up to the tech bubble in 2000 the VIX was hovering around the 11-‐15 range for years, while there was still a lot of upside left in the market. Furthermore, from the market bottom in 2003, until 2007 when we were nearing the market top, the VIX was also holding steady at relatively low levels, fluctuating between 10-‐20, but often hovering around 11-‐15. The takeaway is therefore that a near-‐historic low on the VIX is not necessarily a harbinger of a crash soon to come, but investors should take heed and understand that when the majority of investors are not fearful there might be limited upside and potentially a large downside. Staying on the topic of investor confidence, the Investor Intelligence poll shows that a mere 13% of stock market advisors are bears (have a negative market outlook), which is the lowest reading since 1987 (27 year low) – a year all market participants are familiar with. The poll is made up of newsletters written by investing advisors and determines whether these advisors are bullish (positive) or bearish (negative) on the market. From Investopedia: “The signs of a reversal are strongest when the balance of opinion is strongly skewed in one direction.” Similarly to the VIX, this poll reading can indicate that there is a lot of complacency in the market and that when everyone is bullish there might not be a lot of steam left in the market. However, the world seems to be quite positive on the US these days. Despite a recent poll conducted by George Washington University, which found that 70% of Americans believe the country is headed in the wrong direction, the dollar is strengthening and investors seem confident there won’t be a fallout when Quantitative Easing is ended next month, nor when interest rate (might) start to rise next year. Some people argue that a normalization of rates would be good for the stock market because it means we will be back to more normal market conditions, which will instill confidence in investors. Others would argue that increased interest rates will lead to higher borrowing costs and subsequently break the back of the bull market. But all in all people seem to be bullish on the stock market. Commodities markets are soft, with oil trading below $100, which is good for the economy because it means input costs of production are decreasing. Furthermore, US job numbers have been positive recently, although the August report was soft. You can argue that the unemployment number is decreasing only because people are dropping out of the labor force, however the market does not seem to focus on the “labor force participation rate”. Analysts are more interested in the headline numbers, which for the time being are in a positive trend. The market is generally quite bullish and at the beginning of this month strategists at Morgan Stanley predicted that the market could rally for several more years reaching $3,000 on the S&P 500 (a 50% increase from here). They said this could be the longest US expansion ever, given many factors, one of which being that this recovery has been very slow and is only just starting to reach “normalcy”. The S&P at $3,000 would make most investors foam at the mouth, but I believe it’s a dangerous mindset to espouse. Look at the chart below and you can see that the index is already at record highs, having increased 200% off the March 2009 lows and is currently sitting approximately 50% higher than the previous high, reached in July 2007. Source: Yahoofinance Europe Let’s step away from the US for a second and look at Europe. Recently the European Central Bank’s fear of deflation led it to double the negative deposit facility rate to minus 20 basis points (-‐0.2%), which means that banks are now paying several European governments to lend them money (the same as if you would pay your bank to deposit money into it). ECB president Draghi also recently hinted that he wanted to increase the size of the ECB balance sheet to levels seen a couple of years ago, which would entail printing the equivalent of about $900 billion. These recent events in Europe have led to a significant decline in the Euro versus the dollar, arguably solidifying investors’ confidence in the US and its currency. But possibly the most shocking news is that interest rates around Europe are hitting several hundred year lows. According to Deutsche Bank, Germany is seeing its lowest borrowing costs since the early 1800s (aside from distortions during the 1920s hyperinflation). Spain’s borrowing cost is at a two century low while France’s are at the lowest seen in 250 years. But the most extreme case is the Netherlands where costs have fallen to 500-‐year lows! With these low borrowing rates across Europe, negative deposit rates, and the possibility of a quantitative easing program from the ECB, there might be significant amount of steam left in the market, despite many indicators suggesting otherwise. We are definitely not living in normal times. Conclusion So the answer to the question, “how much steam is left in the market?” is, unfortunately, “we don’t know”. There does seem to be momentum left, however, as I have laid out above we are living in a world of extremes and investors should therefore take precautions. Below is a metric that I have presented before -‐ margin debt. It shows the inflation adjusted (using CPI) margin debt in the market alongside the S&P 500. It tells us that when people are borrowing on margin, stock prices are pushed up. Again, we do not know how far this can go, but the metric is at a record high (see below). Moreover, investors are reaching for yield by buying into risky bonds and there are also reports of large amounts of naked put option writing taking place. If you are not familiar with stock options the second part of that last sentence will read like gobbledygook, but in simple terms it means that people are taking very risky positions betting there will be no market crash. Furthermore, there has not been a 10% market correction in nearly three years, an occurrence that usually happens every year. Source: Doug Short To close off this month’s letter I therefore want to say that we are indeed living in interesting times – with metrics and indicators at record levels. We have scarcely seen situations like this before in history and it is therefore very difficult to predict what will happen. Although many people might believe that the market is at unsustainable levels it doesn’t mean it can’t go higher. The current market has already surprised many investors and there’s no telling how high it will go before the next crash occurs. But although there might be momentum left in the market, it can be wise to reduce exposure because with market indicators at record levels a potential reversal can be very ugly. The Model portfolio I have recently started a new job in an investment strategy advisory company and I have therefore decided to stop publishing the model portfolio to ensure there are no conflicts of interest. I will still keep updating it privately and will share it with anyone who asks. I will also gladly give investing advice to anyone who might be interested. I just want to make it clear, however, that my views have not changed. Readers of this newsletter know what my beliefs are and what investments I have faith in, no matter what is currently happening in the market.