July 26, 2011
SOME THOUGHTS ON THE MARKET AND OUR INVESTMENT POSTURE
Mohamed El-Erian, the CEO of Pimco, someone we greatly respect, expressed our thinking perfectly in the Barron’s of July 25th. He said, “There are some key principles investors should think about. First, they should be able to navigate volatility, because the danger of volatility is it forces you to do the wrong thing at the wrong time. Second, I'd be careful about return expectations. Governments have borrowed returns from the future. [Fed chief] Ben Bernanke said the objective of QE2 was to push asset values up to make people feel richer. The Fed succeeded in asset-price inflation but the transmission mechanism to higher spending hasn't materialized. Third, the tail risks are much bigger: The loss of triple-A status, the possibility of a disorderly default in Europe, of China not being able to manage its success. An investor has to ask, 'Can I afford such a tail?' If the answer is 'No,' they should hedge the tail or look again at asset allocation. And don't underestimate the value of cash; in a volatile world both good and bad assets are impacted, and the higher the probability of being able to buy good assets at really cheap levels. You don't want to be fully invested today.” (emphasis added)
Here at L & S we are not confident that we can predict the future, but we can identify risk when we see it. Today the risk levels exceed our alert metrics to a greater proportion than anytime since late 2008 and early 2009. The Wall Street Journal ran an article this past Saturday talking about “neon swans.” A black swan event is unthinkably rare, immensely important, and as unpredictable in advance as they are inevitable in hindsight. WSJ defined the neon swan event as “unthinkably rare, immensely important and blindingly obvious.”
NEON SIGNS FLASHING RED
Our economic investment metrics continue to flash “caution” and/or “danger.” This does not mean we will stay on the sidelines forever.
We are going through a tumultuous post-bubble healing period. It is not the end of the world. We will endure and will come to the other side of the mountain whenever the next secular bull market in equities begins. We believe that this is not a time to be adding risk, cyclicality, or beta to a portfolio but rather a time to preserve and protect. Cash is our investment choice of necessity.
We believe that anyone making prognostications in this atmosphere is guessing. There are so many variables that can go wrong or right. In this type of atmosphere, we prefer to be on the sidelines in cash.
For most of you, the money you have invested with us represents a significant portion of your investable assets. It is our opinion that this is not a time for taking on significant risks. It is a time for reflection without the burden of volatility and the fear of a significant loss. At this moment, we feel that the risks far outweigh rewards in the markets and that there will be plenty of time and opportunity to capture market appreciation. Be assured that we will be there to participate when we believe that the investment climate has the potential to properly reward our participation.
Please feel free to call us at any time if you have any questions.
Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.
