Harry Newton's In Search of The Perfect Investment
Technology Investor. Harry Newton
AM EST, Friday, May 22, 2009. I have a little
money in a hedge fund. They've usually been pretty good. As you read this
-- an excerpt from today's letter covering April's miserable performance --
think their pain and my old mantra "When in doubt, stay out."
net returns were -3.04 % for April, while the S&P 500 was up
9.39%. Net exposure averaged about neutral during the month. Average
daily gross exposure was unchanged from the previous month at approximately
48%. We will continue to increase gross exposure when stocks exhibit more
reasonable dispersion and lower correlation.
were quite unprofitable during the month. Software, data communications,
hardware and semiconductors were unprofitable. Generally, the stock prices
of growth companies react to revenue acceleration or deceleration and our
data gathering regularly provides us with information advantages to monetize.
In April, the market rewarded companies demonstrating cost control even
when revenue was below expectations. Many of our fundamental shorts, where
we had a negative read on business trends, reported earnings that were 'less
bad than feared.' This was the dominant earnings story for this season.
The majority of companies have reported better than expected EPS, though
many experienced worse than expected revenue. This is a testament to our
economy and corporations, that they were able to effectively cut costs and
lower expenses in a trying period. Furthermore, the market seems to be now
discounting an economic recovery and looking through soft near-term results.
were not sufficiently profitable enough to offset the losses in shorts.
The market rewarded reasonable earnings reports in April; sadly, several
of our larger positions reported their March quarters in the month of May
rather than April. Furthermore, we had a cluster of negative alpha events,
i.e. we were simply wrong more than usual in our stock picks. Although
we have been profitable in over 80% of quarters since July 2002, oddly enough
we have been profitable in only two of seven April months since inception.
We are not sure if this is due to allergy season or randomness.
We were very
disappointed in our April returns. We have always said that sharp market
moves are not conducive to our strategy. After protecting capital in 2008
and investing nimbly for the first quarter of 2009, we encountered an investing
environment that was challenging in unexpected ways. The sharp rally and
shifting market dynamics caught us off guard. Investors seemed focused on
an economic recovery and money flowed to areas which offered leverage in
a recovery in spite of near term business trends.
we have written about our concerns with the debt-fueled nature of our economy.
We have written since 2005 about our worry over the housing bubble, and
the resulting illusion of wealth that enabled consumers to spend well above
their means. Perhaps our continued concerns left us with a negative filter
regarding the data and reported earnings.
Some of the
clear positives in the market include the removal of systemic risk, cash
on the sidelines, tighter credit spreads, robust demand in developing countries,
reasonable inventory levels and improving economic data. Following a horrific
contraction of economic activity, data did improve. Investors in March were
positioned for further market declines. When systemic risk became less of
a concern, investors scrambled to adjust portfolios and put money to work.
The rally off the lows drove to more speculative stocks as investors bought
names that would leave them most levered to potential upside. Investors
appeared to be scrambling to participate in the rally. The fear of under-performance
risk amongst professional money managers created an urgent need to get off
the sidelines and participate in the rally, further fueling gains.
disappointing and in hindsight there are things we would have done differently.
We believe we acted prudently in the interest of our investors. In a month
and a half the mantra swung violently from cash is king
to buy the highest beta stocks so you dont miss this recovery.
Meanwhile, many companies are providing little earnings guidance for the
year as they have limited visibility. While the worst may be behind us,
it is a large leap to assume we are close to getting back to normal. The
state of the economy is being compared to the Great Depression, highlighting
how volatile, dangerous and uncharted this environment is.
season, investors may stop and reevaluate the state of the economy. We made
it back from the brink. Earnings, in many cases, exceeded conservative guidance.
Those who are now saying that this will be a V-shaped recovery must ask
themselves what the drivers of economic activity will be. Investors have
recently been following the traditional recession playbook of buying stocks
when economic data stops getting worse. Those who are buying early cycle
stocks should consider that we might now be in a highly unusual economic
environment, one where the government is a majority owner of many of the
biggest companies and industries. Government will use its power to its own
advantage, but government is known neither for its business acumen nor for
maximization of shareholder value. Populist politics may have unintended
consequences. Regulating compensation will drive talent away from domestic
banks. Halting foreclosures will merely encourage other homeowners to discontinue
mortgage payments; the bumper sticker Honk If Youre Paying
My Mortgage is painfully funny.
is still quite uncertain. Consumers spending rebounded a bit since December,
with higher tax refunds, help from a foreclosure moratorium and perhaps
some pent up demand. Warren Buffett and Best Buy have warned against expecting
the consumer to quickly recover. Many consumer product companies highlighted
that the consumer is retrenching, trading down to cheaper items, saving
more and spending less. Wal-Mart had a large jump in new customers who used
to shop at high-end retailers but are now looking for lower prices.
activity is heating up again. The Financial Times recently published
an editorial suggesting that the U.S. AAA credit rating could one day be
at risk, something we have written about in the past. Supply of stock offerings
and insider selling vastly outweighs insider buying. Government intervention
in the economy is heating up, worrying market participants.
there are many risks. Economic news seems less bad compared to earlier horrific
readings, but there are few indications of a recovery around the corner.
What we just saw in 2008 was the bursting of a multi-decade debt, credit,
and consumption bubble. The ripples of this will be felt for years to come.
You cannot have a multi-decade party and not expect a hangover. The U.S.
consumer has been carrying a heavy load, accounting for over 20% of world
consumption. The enablers of this levered consumption were housing, credit
cards, and the shadow banking system. These pillars are all now structurally
With $14 trillion
of consumer debt outstanding, we are entering a period where people must
choose between saving and consumption. There is no longer any magic ATM
machine from which the consumer can draw. Baby boomers, the largest segment
of our population, are at retirement age but now may be forced to continue
to work after the recent financial setbacks. These people cannot be expected
to invest, save, and also spend. We could be facing a multi-year period
of retrenchment of consumption and muted economic activity. Following a
credit bubble of this magnitude, our economic recovery should not depend
on unprecedented government spending or artificial support for asset prices
but on a repair of balance sheets and capital investment in economic ventures.
stockmarket continued: Now you're thoroughly confused, read this
piece from yesterday's SmartMoney:
Grantham Changed His Mind
IF PEOPLE HAD PAID ATTENTION to veteran investor Jeremy Grantham over
the past two years, their investment portfolios would be looking much better
than they likely are. While many investors were caught up in bull-market
euphoria in 2007, Grantham, who oversees $85 billion for Boston-based institutional
money-management firm GMO, told anyone who would listen there was a global
bubble: Its everywhere, in everything. Then, in early
March of this year, when the market looked its worst, he wrote that people
needed to get over their fears and invest, because U.S. stocks were cheap
and foreign stocks even cheaper.
disregard for the conventional wisdom has brought him grief at nearly every
point of his 40-plus-year investing career. But more often than not, the
often grumpy Grantham, 70, has been right over the long term. The irony
of all his remarkable forecasting is that few ordinary investors can invest
with him. The funds GMO runs are mostly geared toward institutions, such
as pension funds or school endowments, although the Evergreen Asset Allocation
fund invests exclusively in funds managed by GMO. GMO investors lost money
last year because many of its funds dictate a substantial degree of stock
holdings even when the boss is decrying the market. Still, GMOs U.S.
stock funds lost only about half what the S&P did during the crash,
and some other GMO funds did much better.
70, has an opinion for everyone about the best investment strategies in
these uncertain times. Sitting in his office lined with giant Buddhas and
relics of civilizations long gone, Grantham talked to SmartMoney about the
stock market and the current financial mess.
In 2007 you were worried the global financial market could fall apart, and
you said a market downturn was probably coming. Okay, say it: I told
That seems so long ago. I felt like saying that a few months ago, but now
onward and upward, and wait for the next unexpected twist.
were you so certain things were going to get so ugly?
wasnt a whole lot of doubt where I was coming from. I thought the
fair value of the S&P was 925; the S&P went to 1500. And by 2006
the housing bubble was at a 100-year peak. This was the 32nd asset bubble
that weve tracked, and all but the U.K. housing bubble have popped.
didnt you just put all the money in GMOs funds into cash?
quarter, we do our best to tell our clients the truth. We were comfortable
with telling our clients there was a major bubble in every asset class,
everywhere. Then they go to investment committees and decide what to do
with their money. They dont want to do anything that looks eccentric
and costs them their jobs. Its a miracle that any of our advice perks
up the pipeline.
did your own funds lose so much money when you were confident the market
would fall apart?
JG: Most of
our mandates require us to be nearly 100 percent invested. But even when
you had to be at least 45 percent equity, then you couldnt help but
to go down. There was nowhere to hide. Everywhere and everything got hit.
now, for the first time in years, you like U.S. stocks.
JG: We think
a fair price for the S&P 500 index is 900. By sheer divine intervention
we bought into the market on Mar. 6, the day it hit the recent low of 666.
Its likely, but far from certain, that well go back and make
a new low. You arent going to get to buy at the absolute low unless
you have a time machine.
else besides U.S. stocks?
JG: U.S. stocks
were nicely cheap, and frankly, the rest of the world was even cheaper.
In early March, when we bought, we invested only in stocks we thought would
have a 10 to 14 percent average annual return after inflation. Thats
magnificent. We havent seen anything like that in 20 years. It was
somewhat disappointing that prices moved up so fast in just a couple of
weeks. The odds are a bit more than 50-50 that we will go back and test
youve made a quick buck. Now what?
JG: You have
a set of possibilities. First, if the market nosedives, its easy:
You buy. The second is confusing, when the market just goes sideways, between
700 and 800. The market is irritatingly cheap then, but not supercheap.
The longer that goes on, the less probability we will set a new low, so
well ultimately put money each month into the market.
if stocks keep rallying?
JG: If the
market goes higher, above 950, and then starts moving sideways, between
950 and 1050, we probably do very little. Then the market is moderately
the long haul, is there any particular industry or sector you like?
JG: The people
who move quickly in this market can make money. The people who invest in
energy alternatives will make more. Alternative energies and combating climate
change are the single most important economic initiatives over the next
10 yearsreally over the next 50 years. It will be a very exciting
next 50 years.
the future. But why did so many supposedly smart people miss this disaster
over the past two years?
JG: The ultimate
villain of this is the belief in rational expectationsthat the market
tends to be efficient. People who have anything to do with investing either
believe it a bit or believe it a lot. There are only a few of us ornery
disbelievers who dont believe that the market is efficient at all.
wrong with believing that the market is efficient?
JG: If you
believe in it, then you dont see asset bubbles. And theres nothing
as dangerous as an asset bubble. If you even slightly believe in it, you
believe in [former Federal Reserve Chairman] Alan Greenspans idea
that markets can control themselves. You believe that you should buy and
hold the market. You believe you should have a fixed asset mix and you should
never change it, because why would you? The market is efficient! When you
believe in market efficiency, its like being on the railroad watching
the locomotive coming toward you. Then you just stand your ground just for
the discipline of not moving. Its ruinously expensive.
we get out of this mess?
JG: The stimulus
is so great in the United States, China and the United Kingdom, it will
kick the economy up. GDP will go back positive for two to three quarters.
Theyll assume everything is settled, that throwing money at it has
worked. But the long-term imbalance between overproducers [like China] and
overspenders [like the U.S.] will continue. Itll be a multiyear drag
just throwing money at the problems?
JG: If the
problem is that we consume too much and borrow too much, does it make sense
to borrow more and spend more? It doesnt make sense to solve alcoholism
by giving an alcoholic a quart of whiskey, but everyone believes that we
must stimulate. So thats why we feel this is a temporary cure. This
is like when you revive the drunk, he staggers down a few blocks, then falls
does not sound promising.
not rich, and were undersaved and underpensioned. Those will be a
real brake on economic growth. This will be a pretty long recovery period,
longer than were used to, but hopefully not as long as Japan took.
It will not be as long as the Depression, but it will be several years,
and not just two. Lord knows we have had several fat years.
our leaders help?
Obama is not doing the right thing. I admired his appointments in many areas,
certainly in the environmental area. But then he got these tired old retreads
from the financial area that notoriously didnt blow a whistle over
the last few years. Theyve all been Rubin-ized [influenced by former
Treasury Secretary Robert Rubin].
why are these life-size Buddhas and other statues in your office?
a history freak. I find old civilizations fascinating. Great empires all
rise and fall. Its sad that we dont know how the future will
work out. A time machine would be a wonderful device, even if you couldnt
use it for investing.
Jeremy Granthams firm, GMO, predicts long-term returns, adjusted for
inflation, for a variety of assets. Heres its prognosis for the next
GMO has recently warmed to homegrown stocks. It expects a nearly 9 percent
average annual return, above the historic average.
stocks: VERY GOOD
GMO was bullish early in the decade, then turned sour. Now it expects
a 10.7 percent average annual return for large foreign firms and12.7 percent
for smaller ones.
Long-term bonds will average a tiny return of 0.5 percent a year.
Even though GMO expects a 6 percent average annual return, it thinks
stocks are a better deal now.
The full article
is at SmartMoney.
girlfriends Meet for Lunch
had lunch with two of my unmarried friends. One is engaged, one is a mistress,
and I have been married for 20+ years.
At an earlier
lunch we had decided to amaze our men that evening by wearing a black leather
bra & bodice, stiletto heels and a mask over just our eyes. The results:
My engaged friend:
The other night my boyfriend came over and found me wearing a black leather
bodice, tall stilettos and a mask. He saw me and said, 'You are the woman
of my dreams. I love you.' Then we made love all night long.
Me too! The other night I met my lover at his office and I was wearing the
leather bodice, heels and mask over my eyes and a raincoat. When I opened
the raincoat he didn't say a word. We had wild sex all night.
Then I had to
share my story: When my husband came home I was wearing the leather bodice,
black stockings, stilettos and a mask over my eyes. As soon as he came in
the door and saw me he said. What's for dinner, Batman?"
one's priorities straight.
A man seeking to join a south Texas Sheriff's Department is being
interviewed by the Sheriff: "Your qualifications all look good, but there
is an attitude suitability test that you must take before you can be accepted."
a service pistol across the desk, he says: "Take this pistol and go out
and shoot six illegal aliens, six meth dealers, six Muslim extremists, six
Australians and a rabbit."
attitude," says the Sergeant. "When can you start?"
An elderly couple were having dinner one evening when the husband reached
across the table, took his wife's hand and said, 'Martha, soon we will be
married 50 years, and there's something I have to know. In all of these 50
years, have you ever been unfaithful to me?'
'Well Henry, I have to be honest with you. Yes, I've been unfaithful to you
three times during these 50 years, but always for a good reason.
Henry was obviously
hurt by his wife's confession, but said, 'I never suspected. Can you tell
me what you mean by 'good reasons?''
'The first time was shortly after we were married, and we were about to lose
our little house because we couldn't pay the mortgage. Do you remember that
one evening I went to see the banker and the next day he notified you that
the loan would be extended?'
the visit to the banker and said, 'You saved our home. What about the second
'You remember when you were so sick, but we didn't have the money to pay for
the heart surgery you needed? Well, I went to see your doctor and, if you
recall, he did the surgery at no charge.'
'I recall that,'
said Henry. 'You did it to save my life, so of course I can forgive you for
that. Now tell me about the third time.'
Martha said. 'So do you remember when you ran for president of your golf club,
and you needed 73 more votes???
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
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