Slipping just under the wire with my final post on 2015 forecasts, I’d like to cover what I see as likely investor sentiment and behavior patterns as the 3rd part of this forward looking series. Can you believe that 2015 was the future date set in the classic movie “Back to the Future”? And here we are! When it comes to the mass of investor behavior, events in the past are often the same in the future.
Two Guys in a Hot Tub
In Steamboat during the holidays, we get our fare share of wealthy resort travellers. So there are two guys sitting in a hot tub (sounds like a joke right?). Actually there are three including me. Small talk turns to “what do you do”. They are retired, one was a CFO of a “major” US company, and the other was in Oil and Gas for 30 years. Cash is oozing out of their pores. I am a lowly money manager. The conversation goes like this:
Oil Guy: So I guess you’re probably telling all of your clients to just put it all in the Vanguard Index 500 now right?
Me: mumble something incoherent with an awkward chuckle.
CFO Guy: I hope not! I was smart enough to sell all of my Vanguard funds in 2008 (he means the end of 2008 near the lows but doesn’t say that) but I haven’t gotten back in since then. I’m afraid to buy at these levels and I’ve missed this entire bull market. I thought indexing was the way to go but now I’m not so sure.
Me: That’s the first honest statement I’ve ever heard in a hot tub.
Oil Guy: mumbles something incoherent with an awkward chuckle
Funny and true story. Investor psychology is now in a bipolar state captured by these two gentlemen. Some like our Oil friend are committed to buying more and more of the same S&P 500 index funds on the assumption that returns are cheap and easy. Their intentions are to passively hold their index positions but we know what happens when these become less productive and doubt enters the picture following deep declines. The trap is set for this fella but he is voluntarily walking into it nevertheless. Our other CFO friend is skeptical but ultimately will give in to his emotional need to participate this year. He will take steps to buy something with his cash as many are doing now. That something may not be a stock index fund but more likely something that seems safe – More on this in a minute. Again, the trap is set for the latecomer buying the wrong asset at the wrong time. Strangely, the stats on investor confidence show that more investors are in the CFO guy’s camp making the assumption that the markets are now overvalued and subject to downside risk. This is not a new phenomenon as this negative and falling sentiment toward stock valuations has been with us since 2012, even as prices continue to rise year after year.
If the past is our guide to the future, I’m going with the assumption that some time in 2015, investors will find stocks attractive again, either by way of a deep correction or by way of capitulating to sharply higher prices. There is a reasonable chance of both events in 2015! Buckle up.
Buying Back In – But To Something “Safe”
As I mentioned above, our CFO friend is going to put his money to work this year. I can hear it in his voice. Cash moving from money market funds into the US financial markets will happen in 2015 as long as prices continue to trend higher. The real question is where will it go? Given the skepticism identified in the fine Bespoke chart above, it seems that investors will reach for participation as a means of adding net exposure but their selection will be in something with perceived safety and strong recent history or performance. US Treasury bonds and Utilities come to mind based on some wild outperformance in 2014. Utilities on average are currently earning 2-3%/ year (EPS). In 2014, they gained nearly 30%. They are the most overvalued they have been in the last 25 years. We currently own utilities but they are on the chopping block now. Long term US Treasuries tell the same story with an annual yield of 3.3% and gain of 27% in 2014 erasing all of 2013 LOSSES by a few points. The Barclays Aggregate Bond index didn’t fare as well but did produce enough return (+6%) to attract that investor looking for something “safe”.
Bespoke did a nice job of running sector valuations relative to their long term median levels and came up with the following. Mind you, a sector or the market for that matter, can remain overvalued or undervalued for a very long time, much longer than we might expect. Overvalued is not a sell order but simply a condition to be aware of. Same goes for oversold – but the opposite.
Investors looking for something safe to buy amid their valuation skepticism should be looking to the top 5 sectors groups showing lower “current” values compared to “median” values. I think telecom should be top of the buy list as these stocks and funds also tend to pay out some of the best dividends. We plan to rotate some of our current utility positions to telecom and materials in the coming weeks as we already have a large stake in technology and industrials. Energy is now on the watch list for us but it’s still too early to buy that sector. Buyers beware, safe investments for your reinvestment strategy based on past returns may be just the thing to avoid in 2015.
Banking on Forecasts (including this one)
According to the average institutional money shop, the US stock market should gain 8.1% in 2015. This the median forecast. Very oddly, these same forecasters got it almost exactly right in 2014 with returns coming in at 11%, the median was for 12% this time last year. It would be a small miracle if these forecasters got it right two years in a row – they are never right and usually not even close at this time of year. They do a great job of changing their forecasts in June (wink). Investors would be wise to assume nothing in 2015. I would offer that a range of returns for the S&P 500 will be plus or minus 14%, roughly 2300 on the upside and maybe 1740 on the downside for the S&P 500. Big swings will drive big flows of funds in and out of stocks mostly at unfortunate times. My advice is to try to position your portfolio early in the year for an increase in volatility. I would recommend reaching into the non-correlated investment world, which we are doing, now by increasing our allocations to “liquid alternative” funds like managed futures funds, REITS and Long short funds. Our goal is to get comfortable with a more diversified mix of holdings, gradually cutting equity exposure at the same time as stops are hit. I too see and read all of the good news related to consumers, the US economy, to low gas prices and interest rates with no risk of inflation. I understand the aggregate expectation of 8% returns. But when all the news is perfect, we should all be watchful for the unexpected.
And this ends our three part series of forward looking wild guesswork. And so it begins…
Thank you for being our valued clients – we truly appreciate your trust and confidence and never take your business for granted. We humbly look forward to serving you in 2015.
Cheers
Sam Jones
