I keep watching the frustration and hesitation in money managers' inability to capitulate; to admit that they have had it wrong and change course to reflect reality.
Nearly 84% of all hedge funds have underperformed the averages year to date. No wonder why withdrawals have escalated and passive managers have benefitted. You have to step back and ask yourself why and what does this all mean for professional managers aAnd investors in the future.
Will all the money move to index fundsA, robo managers or electronic/black box traders? Ask yourself why "Warren Buffett style" Investing succeeds year after year, with some years being better than others?
The past is not prologue and most managers cannot seem to adjust their mindset to recognize that change is everywhere. I listened last week to Lee Cooperman of Omega whom I have known for over 35 years and totally respect as a brilliant investor. However, it was clear to me that he missed the boat and is looking in the rear view mirror to make future decisions. He is less than 65% net long and continues to underperform the averages. Let me give you one example of where I feel that he is off base. While he is in the pro-growth camp forecasting higher S & P earnings boosted by better energy and material profits, he is using only a 17 multiple for 2017 therefore saying that the market is fully valued today. Here's the rub. He is using a "normalized" 10-year bond yield of 3.5% down the road to compute his market multiple which, if true, paints an extraordinarily strong economy, higher inflation and much higher "normalized" earnings than most expect today, including ourselves.
Our view remains that the 10-year bond rises to 2.5% next year from 1.50% today as the economy maintains 2.0+% growth and the yield curve steepens slightly. Our market multiple is 19+ times 2017 S & P earnings of $125 per share which happens to be the same as Lee's forecast. Therefore, we see 10% upside for the averages from here. While it is true that Lee and I don't buy the averages and our stock selections tend to beat the market by a wide margin leading to our outperformance over our careers, the differentiator is that Paix et Prospérité has continued to outperform the averages over the last several years while he and most other hedge funds have not.
Why have we continued to be successful when the vast majority of managers have fallen short? We have been on the mark with our core beliefs that serve as our North Star guiding us at all times. We maintain a truly global perspective analyzing all variables and the inter-relationships of all markets needed today to be a successful investor; and we have found excellent investment opportunities through independent research. Lastly, we have recognized that we are living in a period of dramatic change. Change creates opportunity because it means that the past will not be prologue for the future. As I have said at many conferences, it is our job to create charts rather than follow them, which creates our alpha. We combine a top down global perspective with a research driven bottom up analysis of each investment opportunity. We are that master chess player cognizant of our next move while planning three or four moves down the board. We anticipate rather than react and always control risk by maintaining excess liquidity, like Buffett, to be able to take advantage of the unexpected events that may negatively impact the markets.
Three things stood out to me last week: the monthly job numbers; a sharp acceleration in exports resulting in a declining trade deficit; and the G-20 meeting in China. My underlying conclusions from each are that our economy remains on a 2% growth path for the year with an acceleration in the second half due in large part to inventory accumulation and a declining trade deficit; growth overseas is improving albeit slowly; and China as well as Russia are standing out at the G-20 conference while the U.S and Western European leaders are not which should serve as a wake up call for all of us.
Everyone was focused on the August jobs report especially after all the comments from Fed members at Jackson Hole that this number would tell us whether the next hike in the funds rate was now or later. Well, we all held our breaths when the clock hit 8:30am EST on Friday and the report came out. By now you know that the number came in less than expected, hours fell and hourly wage gains were still moderate at best. I still find it hard to believe that everyone fears a small increase in the Funds rate from these levels when in fact we need to return to normalized levels which are above current rates. The bottom line is that the Fed is out of the way until after the election and our prediction last January of "one and done" for the year appears on the mark.
The trade numbers also reported Friday were far more interesting to me than the employment number. The trade gap narrowed by around 12% with exports rising 1.9% and imports falling by 0.9% despite a strong dollar. These numbers are consistent with better growth numbers being reported overseas and supports our view that the global economy is improving as we enter the second half of this year.
It appears to me that China and Russia are exerting their influence and gaining strength at the G-20 meeting being held in Hangzhou China. Chinese President Xi Jinping has stood out hosting this conference and has done an excellent job pointing out the strengths of China and the country's path for future growth emphasizing consumption over production and investment in high tech industries. It's almost ironic that he is calling for more investment and free global trade as the West seems to be moving in the opposite direction.
The United States appears to be a major impediment to both the Trans-Pacific and European bloc trade deals. Both of our Presidential nominees are against these deals. We need more less-restrictive global trade deals rather than less. All parties must be held accountable.
Vladimir Putin, President of the Russian Federation, has really taken advantage of the current unstable global environment by working closer with Turkey and Japan and also calling for a oil production freeze while permitting Iran to return to its former percentage of OPEC production. His status as a world leader is rising. I am sure that the final communiqué from the G-20 will be the same as all others calling for more cooperation amongst all members and more fiscal, tax and regulatory reforms to stimulate growth. Actions speak louder than words.
What concerns me most today is the failure of our politicians to act. Do you realize that a majority of our country doesn't like nor trust both of our Presidential nominees? We can and need to do better than this. Both parties know the issues and really know the solutions but ideology, ego and the unwillingness to negotiate keeps anything from happening. Fortunately our economy, companies and people are resilient and succeeding for the most part in spite of our politicians. I find it so disappointing that opportunities have never been better for this country if only we made the right policy changes needed to win in today's global environment. Other nations face the same challenges and it's time for coordinated efforts by all to right the ship to global prosperity.
The bottom line is that the market remains statistically undervalued and the global economies are improving despite many impediments to growth. The call for change is everywhere and opportunities to profit from change have never been better. Stop fighting the tape and start looking to the future rather than the past as your guide.
We continue to emphasize companies that will benefit from more global growth, a tick up in inflation and a slightly steepening yield curve and reduce our exposure to the "safe" stocks including drugs whose pricing will come under more scrutiny.
So remember to review all of the facts; step back, pause and reflect; consider mindset shifts; review asset allocation and risk controls maintaining excess liquidity at all times; do independent research on each investment and...
Invest Accordingly!
William A. Ehrman is managing partner at Paix et Prosperite LLC.