Don't Wait for the Robins:
Investment Strategy for 2013
By Pamela Rosenau
December 28, 2012
Warren Buffet, the Sage of Omaha, once remarked, “If you wait for the robins, spring will be over.” “Uncertainty” has been an overarching issue since the financial crisis of 2008 and one of the principal reasons that investors have remained on the sidelines away from the equity markets. As it has been a part of the investment lexicon, “uncertainty” will always exist in some capacity. In 2012, investors began by focusing on European issues, then the U.S. election, and now the fiscal cliff. In fact, when there is little uncertainty and investors appear unafraid, one should be more concerned. Nevertheless, bonds have continued to attract investor money this year despite equities appearing to be increasingly more attractive. In a market with negative real interest rates, equities may be inherently more volatile than other asset classes; however, owning government bonds, for example, may incur more risk as their volatility has been “artificially suppressed,” something that cannot be maintained in perpetuity.i As a result, owning bonds is somewhat dangerous. On the other hand, in the coming year, equities should experience an upward rerating and be further supported by the latest central bank (i.e. the Bank of Japan) which is expected to enact an easy monetary policy. Per economist Anatole Kaletsky of Gavekal, a massive increase in worldwide money supply would have an inflationary effect on the global economy, which would be very bullish for equities.ii Investors waiting for various “uncertainties” to pass may be late to the party. Overall, we are entering an investing environment in 2013 where “macro” factors will continue to be the driving force, but fundamentals will be increasingly significant.
The chief investment strategist at BofA Merrill Lynch, Michael Hartnett, stated in Barron’s that “his wife once said that the best part about living in London was….Paris.”iii Hartnett thinks “the best thing for the stock market in 2013 might well turn out to be….bonds.” Per Hartnett, the 30-year Treasury yield has been hovering near 3%, above the lows for the year at 2.5%, which may be a sign that bonds are beginning to price in a recovery given the strong stock performance of homebuilders and banks this year. Another 0.50-1.00% move up in the long rates could “corroborate the notion that a stealth rotation from bonds into stocks has begun,” according to Barron’s journalist Kopin Tan.iv He adds that the proposed deal to “sell the storied 220-year old New York Stock Exchange to a derivatives upstart [may] mark the bottom of our indifference toward stocks.” Additionally, a recovery in durable goods may also provide a lift to equities. “Durable goods tend to have a very strong correlation with the S&P 500 (see below),” a pretty compelling chart.v According to Orcam Financial, “the directional trend in orders has tended to track the directional trend of the overall market.”vi
Even with an increase to the dividend tax rate, U.S. large cap dividend paying multinational stocks remain attractive as they have not been impacted historically by previous dividend tax reform. More importantly, per Raymond James, U.S based multinationals have “decoupled from just being part of the U.S. economy.”vii A larger share of profits of these “flagless” corporations is earned overseas in places like Asia, Africa and Latin America. These S&P 500 companies are no longer “just U.S. companies.”viii Furthermore, they provide a stable, growing source of income, which is higher when compared to fixed income government securities. According to Jim Paulsen, the chief market strategist at Wells Capital Management, an equity market climb in 2013 will be “a confidence-driven run”.ix As we have been climbing a “wall of worry” over the past four years, December fund flow data according to Lipper reveals that this shift in confidence may be beginning to take place. In December, “flows into stock-based mutual and exchange-traded funds have totaled about $8 billion so far, while bonds have taken in less than $1 billion."x
Although we do not anticipate the Fed raising rates in the near future, it is possible that they take their foot off the gas. Per BlackRock, 2013 could very well be a tale of “two halves”.xi If a Fed reversal were even mentioned, investors would flock to equities and transition out of fixed income. In this scenario, dividend payers may underperform more leveraged stocks that are further out on the risk spectrum, “as the influx could result in a temporary ‘dash for trash’.”xii Even in a ‘dash’, we prefer the dividend payers as we get paid to wait and would not sacrifice the quality of the companies in our portfolio. Scott MacKillop of Frontier Asset Management states that “it is tempting to suggest to [clients] that we know how to turn risk on and risk off like a light bulb so they will be protected in difficult times and can benefit in good times. However, we should resist the urge to do so and, instead, do the harder work of helping them gain proper perspective.”xiii Quite simply, equities are cheap. Per Strategas, equity risk premiums are high on a historical level (over 2 standard deviations above the 50-year historical average).xiv According to Charles Gave, the equity risk premium (or the earnings yield less the 10-year Treasury yield) of stocks is so large that you can buy them effectively on a cash basis without having to discount future cash flows. As the Fed is “constraining volatility and the value of long duration assets, you want to go long volatility.”xv The real “definition of risk, in an era of false prices, is capital impairment, not volatility.”xvi Or as the financial historian Elroy Dimson states, “Risk means more things can happen than will happen. It is not standard deviation. It is not variability. It is this sense that future events are highly variable and unknowable that gives us the best sense for risk.”xvii
As the Fed has been easing over the past five years, Japan, one of the largest economies in the world and the third largest private pool of savings, has just begun to take steps in weakening their currency. One of the main questions is, what will Japanese households do with their savings? Will they export their savings or invest them at home in an equity market where Japanese exporters will benefit from a weakening yen? Although some currency speculators have lost so much money shorting the yen that the currency earned the nickname the widow maker, the fundamentals do support a weaker yen outlook.xviii For example, Japan’s current account has deteriorated over the past few years, and the seasonally adjusted monthly current account was in deficit for the first time in thirty years. Essentially, they are importing more than they are exporting, as a stronger yen in recent years has hurt their competitiveness abroad. “In the absence of growth, foreigners are less inclined to invest in the country,” which puts “downward pressure on the currency.”xix As the world experiences “competitive devaluation”, the yen will become much weaker compared to currencies offering higher yields. Japanese savers are both “income hawks and momentum seekers” and as a result, the yen will now join the US dollar as a preferred currency to fund “carry trades.”xx
In addition, there has been some corporate reform in Japan over the past ten years that has led to many more defined contribution plans rather than defined benefit plans.xxi Retirees are now more cognizant of their investment returns. In addition to spurring carry trades, a weaker yen should create a tailwind for Japanese exporters. In fact, “the Nikkei index, when measured in dollar terms, has generated returns that are fairly close to that of the S&P 500” since 2002.xxii Per BCA Research, “the underperformance of the Nikkei has been entirely made up by the appreciating yen. For the last 10 years, the negative correlation between the yen and the Nikkei is almost perfect,” a key reason why a call on the Nikkei is essentially a put on the yen.xxiii According to GaveKal, in the past, “large devaluations of the yen have tended to put pressure on profit margins elsewhere, and were thus typically bad news.” However, major monetary easing by the world’s largest central banks has created a rally in risk assets. When Switzerland eased during the crisis with their bond purchase program, it helped finance the eurozone budget. With Japan’s larger economy, their increased liquidity would have an outsized favorable global impact, particularly for the equity markets.
The Rosenau Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC & HighTower Advisors, LLC, a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.
This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates. In preparing these materials, we have relied upon and assumed without independent verifications, the accuracy and completeness of all information available from public and internal sources. HighTower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them.
This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. Carefully consider investment objectives, risk factors and charges and expenses before investing.
iCharles Gave. Welling on Wall St. December 21, 2012.
iiAnatole Kaletsky. GaveKal Conference. New York Seminar. December 19, 2012.
iiiTan, Kopin. Barron’s. Streetwise. What a Gold Mine. December 24, 2012.
vRoche, Cullen. Pragmatic Capitalism. December 21, 2012.
viiRaymond James. The Big Picture for 2013. December 27, 2012.
viiiRoche, Cullen. The Rise of Macro Investing. December 25, 2012.
ixCox, Jeff. CNBC. Bye-Bye Bonds? What Fund Flows Say About 2013. December 26, 2013.
xiBlackrock Investment Institute. Slow Turn Ahead? 2013 Investment Outlook. December 2012.
xiiiMackillop, Scott. FundFire. The Perils of Risk Management Obssession. December 20, 2012.
xivStrategas. Charts of the Week. December 21, 2012.
xvCharles Gave, Gavekal Conference. New York Seminar. December 19, 2012.
xviiAdvisor Perspectives, Best Investment Related Quotes, December 27, 2012.
xiiiMerk, Axel G. Financial Sense. Is the Yen Doomed? November 28, 2012.
xxCharles Gave, Gavekal Conference. New York Seminar. December 19, 2012.
xxiBCA Research. Special Report. December 21, 2012.
Pamela Rosenau is Managing Director & Equity Market Strategist at HighTower; Co-Chair of the Steering Committee of HighTower Group Investment Solutions; and Chief Investment Officer of The Rosenau Group. Ms. Rosenau is a macro, visionary, non-consensus thinker that places an emphasis on risk minimization and misunderstood market moving signals. With over 25 years of experience in the financial industry, her tenure in investment management is best reflected in her core strategy which has historically outperformed the S&P 500 benchmark in down markets. Prior to joining HighTower she worked for various sell-side firms beginning her tenure with Wertheim & Co./Schroders Plc. She was recently ranked #15 in Barron’s 2012 Top 100 Women Financial Advisors, and was also chosen for Barron’s 2012 Top 1,000 Advisors list, ranking #46 out of all financial advisors in California.
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