Confessions of a Frustrated Fund Manager
NOTE: Every week or two I write a Client Note for my clients. I post most but not all of the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
It’s been about 6 months since you last heard from me. That’s not because I haven’t been following the market or thinking about it regularly. I have. It’s because I have simply been stonewalled by this relentless bull market. In fact, while everyone thought the election of Donald Trump would result in a massive selloff, the S&P 500 is up 11% since November 8!
The reasons for the rally since Trump’s election are threefold. First, Trump has promised a lower corporate tax rate which would, of course, juice earnings. Second, Trump has promised to reduce regulations, especially those on financial institutions, which has led to a huge rally in the financials. Finally, Trump has promised a huge infrastructure program which has led to a corresponding rally in industrial stocks.
My concern is that this rally was from already high levels and the 11% move, and much greater moves for some individual stocks expected to especially benefit, mean that these policies are already priced in.
The catalyst for today’s Client Note was an article on page C1 of today’s (Fri 3/10/17) Wall Street Journal: “When Should Bulls Pivot Into Bears?” by James Mackintosh. In it, Mackintosh suggests that most professional currently believe that the market is toppy and overvalued. However, they are afraid of missing a potential blowoff top. That is not a good reason to be invested in my opinion! Bank of America Merrill Lynch strategist Dan Suzuki said: “It’s euphoria taking hold. We’re in the cautious camp [on valuations]. We’re just trying to recognize that that’s not what drives markets.” Ed Yardeni of Yardeni Research said that to make money from here “you’re not making it as an investor, you’re making it as a speculator.”
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I also want to comment on the continuing shift into passive investing via index funds. Active management is under attack and losing the intellectual battle. Investors are shifting more and more money away from active managers and into index funds that simply mirror the market. Hedge funds are underperforming and losing money. It has gotten so insane that Warren Buffett, the foremost practitioner of active management, actually bashed it in his recently released annual letter.
In the letter, Buffett outlines a $500,000 bet he made with Ted Seides, co-manager of fund of funds, a fund that invests in a variety of hedge funds, Protege Partners. Seides picked five fund of funds to compete with Buffett’s Vanguard S&P 500 index fund. Through the first nine years of the ten year wager, Buffett’s index fund has returned 85.4% while Seides’s funds of funds have returned between 2.9%, 7.5%, 8.7%, 28.3% and 62.8%, respectively. In other words, Buffett is going to win this bet.
Buffett goes on to say that this is likely to continue because the previous nine years have been “typical”. No they haven’t! The last nine years have been characterized by the most radical monetary policy in the history of the world which has inflated asset prices to extraordinary levels. Buffett’s timing, as usual, was fortunate, even lucky, in my opinion. I would bet on the hedge funds for the next 10 years personally.
Buffett’s attack on active management was disappointing to me for a number of reasons. First, it strikes me as hypocritical. Buffett has made his money and name as an active manager. How can he attack it when that’s what he does? Second, and relatedly, it comes off as arrogant. He seems to be saying: me and a few other exceptionally talented individuals can do it, but you can’t. Lastly, it is discouraging to young investors and others like myself who hope to emulate Buffett by creating an edge to beat the averages over time.
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In conclusion, this market environment has become extremely frustrating, confusing and depressing to me. I quite simply don’t know what to do except wait it out. I am by nature independent and contrarian and so it is impossible for me to invest simply because that is what others are doing. I need to have conviction in what I am doing. I should also say that I am not alone. Paul Singer, Jeremy Grantham, Seth Klarman and many other legendary investors have expressed extreme skepticism about this market – and been wrong too.