Transcript Document

Market Mosaic
September 2014
Phillip J. Kosmala, CFA
Managing Partner
Joseph D. Taiber, CFA
Managing Partner
Company Overview
 Chicago based firm founded by Joseph D. Taiber, CFA and Phillip J. Kosmala, CFA
 Over $4 billion in asset under advisement across a national clientele with client tenures with the
firm’s founders dating back to the late ‘90’s.
 Our investment professionals average 18 years of industry experience, have worked together as a
team for over 13 years, and bring over 70 years of combined experience across a diverse set of
backgrounds including years of SEC regulatory experience, chairing investment committees of two
separate national multi-billion dollar investment consulting firms, and directing the alternative
investment research group of a multi-billion dollar investment consulting firm
 Substantial industry experience having consulted to top performing university endowments, large
state pension funds, national foundations, large healthcare organizations, and Fortune 500 corporate
DB and DC pensions in all aspects of their investment programs
 100% employee owned. Measurable performance based incentive structure for all firm employees
rewarding exceptional client service, value added client investment recommendations, and team
oriented research contribution
* CONFIDENTIAL *
Firm Philosophy
Manager
Intelligence
Internal
Research
Independent
Research
Informed Decision
Making
Enterprise Knowledge Management
• Gathering, warehousing, sharing, processing market
intelligence
1. Over 1,000 manager meetings per year
2. Over 20 independent research sources
3. Detailed weekly investment committee meetings
• Valuations, fundamentals, technicals,
sentiment, economic, political
• Region, sector, industry, holdings thesis
• Encourage natural curiosity in a collaborative team based
environment
* CONFIDENTIAL *
Asset Allocation Decision Process
•Identify asset class
headwinds and tailwinds
•Money supply, liquidity,
lending trends
•Growth trends
•Leading indicators
•Rail data, retail sales, etc.
•Understanding what is priced
in to the market
•Avoid Overvalued Asset
Classes and Strategies
•Earnings multiples
•Credit spreads
•EBITDA multiples
Macro
Economic
Variables
Fundamentals
/ Valuations
Portfolio
Positioning
Sentiment
•Identify and exploit tactical
(12 month) and secular
trends (1-3 years)
•Adjust portfolio over/under
weights
•Select managers, funds or
ETFs
•Analyze 1) the Laws of
Supply & Demand and 2) the
impact of fear & greed
•Mutual Fund/ETF flows
•Moving averages
•Inflation expectations
•Volatility indices
* CONFIDENTIAL *
Historical Context – Bear Market Indicators
We were well overdue for a 5% correction and remain overdue for a 10% pullback. This is the 5th longest streak in the history of the S&P without a
10% correction and, until February 3rd, the longest period without a 5% pullback in nearly a decade. Historically, 10% corrections occur every 13
months and 5% corrections 3.3 times per year. 2013 was a year of benign volatility with only one 5% correction (May 21-June 24 led to a 5.76%
drawdown). The last year with a single 5% correction was 1961 (as an aside, 1964, ‘93 and ’95 offered no 5% corrections). The current bull market
has already registered 18 drawdowns greater 5%.
We reviewed all 14 bear market corrections that lasted more than 3 months since 1950 and studied common factors. No single factor predicted the
correction successfully more than 11 times and even the more successful indicators provided numerous misleading sell indicators; however, when the
weight of the evidence is considered, these indicators can help mitigate dramatic drawdowns. It should be noted that in 13 of 14 observations, EAFE
had a correction coinciding with the US, so there is nowhere to run or hide equity-wise.
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4.
Monetary Conditions
a. Yield curve inversion: not close
b. Short real interest rates move above 2%: we just broke -2%
c. M2 broad money supply growth falls below the rate of real GDP growth: M2 is north of 6% while GDP is 2%
Valuation
a. Trailing and fundamental PEs are horrible predictors in the short term - market declines have begun when the price-earnings ratio or
other valuation measures have been standard deviations below their historical mean. This remains true even when using highly
smoothed earnings (Shiller CAPE) to make the calculation. Valuation does work over longer time periods as higher PEs lead to greater
magnitude corrections. High PEs have coincided with greater bear declines.
Economic Outlook
a. ISM and LEI are useful, but not great indicators – too many false signals and, more importantly, corrections have occurred despite
positive and increasing readings. That said, both are more useful than not: currently, both are indicating expansion in the US and most of
Europe.
Technical
a. These include breadth (advance/decline – rolling over a bit, but still in an uptrend), extreme sentiment (clearly evident entering 2014),
moving average breaks (the 50 day is completely useless – 4 breaks in the past year have all been recovered in a week; however, a fall
2.5% below the 200 day has been highly problematic) – not close to the 200 day yet.
b. Overall, technical is the weakest of the four bear market indicators.
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Current Views
Macro Economic Backdrop (positive)
Global liquidity is the most important factor in identifying changes in market trend (more important than valuations
and technical). Despite the end of QE in October, liquidity is accelerating as bank lending increases and the ECB and
BoJ accelerate their QE programs. Furthermore, China money supply growth is accelerating.
Pillars to bullish case:
I)
Central bank put - .95 correlation of S&P to the Fed’s balance sheet
Accommodative Central Banks - negative real interest rates in most developed markets. NOTE:
historically, most bear markets start when we move from a negative real rate to a positive 2% real
... current reading is near NEGATIVE 2%.
•
US money supply growth rate now 6.7% and rising - well in excess of GDP
II) Eurozone tail risk remains compressed
• Credit spreads tighten as ECB pledges additional stimulus
• Next test – ECB’s Asset Quality Review in November (catalyst for bank lending?) and the
market's response to the ECB's latest round of QE in September
III) Earnings growth remains positive and easily leaped over the low 2Q bar (4.3% revenue growth,
9.9% EPS growth) - WAY ABOVE Street estimates. Margins remain strong and guidance has been
improving.
• Q1: Third largest share buyback quarter ($188 billion) in the past decade- also a boost to
earnings for the coming quarters
IV) Synchronized global economic expansion
• Weight of the economic evidence is still positive (second derivative is slowing)
• Bank lending and capital expenditures rebound in the US
• Rail car loadings and traffic up sharply; ISI Trucking survey at 9 year high
• JOLTS seekers/openings ratio at 2002-2006 average; employment diffusion index also
back above historical average
• NFIB Small Business Confidence increases to 2007 levels
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Current Views
Macro Economic Backdrop (positive)
Primary risks to the bullish economic backdrop:
I)
Policy/interest rate trajectory
• Political pressure (QE efficacy) and modest labor market improvements inducing central bank
hawkish tone. Reaction to strong Employment Cost Index reading in late July underscores the
thesis
• Fed move from quantitative to qualitative forward guidance should increase volatility
II) Stalling of economic conditions in emerging markets or Europe (Ukrainian/Russian issues impact
European gas imports). Iraq instability forcing oil prices higher? This is the BIGGEST RISK ON THE
BOARD in our estimation...
III) Elevated earnings estimates in late 2014 create higher bar to justify multiple
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The Central Bank Put
Source: Bianco Research, L.L.C.
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… but U.S. & Global Economy are Moving in the Right Direction
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… and Inflation Remains Subdued
Economic Data: Recent Observations Improving Globally
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Economic Data: Rates Likely to Remain Low as Fed Favored Metrics Remain Tame
Source: Bank Credit Analyst
Source: Bianco Research, L.L.C.
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Current Views
Fundamental/Valuations (neutral)
• US equity markets fully valued
• Current P/E multiples 15.8x. Long term averages approximately 14x.
• Internet, biotechnology, and smaller cap stocks trading rich.
•
International and emerging market equity valuations look inexpensive relative to U.S.
• Broad European equity markets trading at approximately 40% discount to U.S. on cyclically
adjusted basis
•
Credit spreads are tight relative to historic norms, but not at extreme levels
• Unlike 2008, high yield maturities are 4 years off
• HY spreads have been tighter than current readings for several years (2004-2007) and (97-99)
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Equity Valuations
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Equity Valuations – Earnings and Revenue Estimates for 2Q
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Equity Valuations
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Equity Valuations
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Fixed Income Valuations
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Fixed Income – Demand Outpacing Supply
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Source: Citibank, Eaton Vance, Deutsche Bank
Current Views
Technicals / Sentiment (neutral)
• Fear metrics remain contained despite the July/early August drawdown
• CDS, credit spreads, shape of the yield curve, 10 year bond yields, VIX, and VIX
futures/options
• TIPS breakevens reverse course
• Futures vs cash bonds – volatility waiting to happen?
• 21 largest strategists average year end target at 1968 on the S&P 500
• Dry powder in private equity hits an all time high in June $1.14 trillion
• Security correlations coming down quickly
• Sector correlations fall to 70% from 85% (mid to upper 90% since 2011)
• Other technical trends of note
• Treasury rally (74/75 economists see higher rates in 6 months) and year end 3.10%!!! JP
Morgan survey shows all managers underweight treasuries - hard to imagine a run away in
rates given that everyone is on one side of the trade already! Further, international demand
for treasuries is soaring as German 10 year yields fall below 1% (2.40% does not look so bad
in that light!)
• Emerging markets (debt and equity) flows positive, most still pessimistic/ underweight on
the asset classes - good contrarian play
Tactical Opportunities
•
Best Ideas:
• Style: Growth over value, large cap over small cap, credit (especially high yield) over
Gov’t/Agency
• Sectors: Technology, energy renaissance (MLPs, North American E&P)
• Asset Classes: Frontier & emerging markets (equity and debt), international small cap
• Niche Dislocations: closed end funds (trading at extremely wide levels again)
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100% of Economists Bearish on the 10 Year!
Source: Bianco Research, L.L.C
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Fear Barometers Remain Rise In July, But Remain Well Contained
Source: Bloomberg
Source: Bank Credit Analyst, Bloomberg
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Despite the Increase in Debt, Europe’s Deflationary Threat Keeps a Lid on Rates
Source: Bank Credit Analyst
Excessive Complacency Not Evident Here
Source: Bespoke, BCA
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Historical Context – Trade in May and Go Away?
Source: Leuthold
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Appendix
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Historical Context
Source: Bank Credit Analyst
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Historical Context
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Historical Context
Source: Bank Credit Analyst
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August Returns & Yields
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