Where Have All The Investors Gone?
Given that most trading in capital markets today is momentum-based buying and selling, where much of the trading is a reaction to news and directed to ETFs that are being manipulated by computer algorithms, it’s a legitimate question to ask where have all the investors gone?
Is most everybody today just a buyer or a seller of prices? If so, the marketplace has gotten off track. Are people fed up with market intervention, are they too indifferent to market risk until they panic or are they simply not able or not caring to understand the assets they are buying?
We think this is an important issue that must be discussed in the context of a possible bubble that, if and when burst, would destroy trillions of dollars of wealth.
Does Friday’s drop of almost 700 points in the Dow index mean the bubble has just burst?
As professionals we understand how to invest in the market. Our biggest concern for the buyer, which the public may not appreciate, is that Humongous Bank & Broker (HB&B) is rapidly replacing knowledgeable Investment Advisers on the front line with Customer Service Representatives whose primary job is to gather assets. These people are not experts at portfolio management or trading. To support them, HB&B has given them a simple ETF product that meets, apparently, a client’s needs for liquidity. That development of ETF’s has led to self managed account acceptance as well.
With mutual funds, a salesperson informs the customer about assets that would meet that person’s financial needs, presumably based on the KYC (know your client) process. While such information being passed back and forth is often miscommunicated or not strictly followed in many cases, at least there is a discussion that takes place, and some understanding of the product by the owner of the account.
On the other hand, with do-it-yourself managed ETF trading, whether active or passive in nature, traders are mostly following price motion alone. If there is a hook at the bottom of a squiggly line, they buy. If the hook happens to be at the top, they sell. For all they know about the underlying assets, the ETF name might just as well be named a number, like the stocks in Hong Kong and South Korea for example.
In our view, whether we are buying a house, a car, a bunch of bananas or stocks in the market, investors need an understanding of any asset they purchase. As investors, we are not simply buyers simply because a price today looks on the charts to be going higher next week or next month.
In the simplest terms, investors are seeking either “Value” or “Income”. For income, we select the instruments involving distribution of funds that meet our current financial needs. For value, we are looking at future needs. We seek to invest where the current value of an asset is less today than is likely to be the case sometime in the future. We determine value in a company by its ability to generate future profits and earned surplus from operations that will increase its worth as an asset, reflected at that point by a higher share price.
In other words, we view a stock in terms of the underlying fundamental worth of the company as well as its stock price in the market. If the fundamental value, as determined by various calculations such as discounted cash flow, is either less or close to its current stock price, we refer to this as a value stock. If the company’s operational revenue and earnings are growing at a faster pace than its peers, we call it a growth stock.
In whatever way we look at it, every investment discussion is one about value – value we see today or value we have reason to believe will occur in the future. If a purchase is not an investment in value, it’s a speculative purchase.
To run an investment fund, the manager needs an investment discipline. Ours is simple: (1) we select companies that are outperforming the field of candidates on a corporate fundamentals basis, with very high rankings, and (2) we use technical indicators like RSI, CCI and others to buy into extreme weakness and sell into extreme strength, always trying to hold at least a small % investment in each instrument where profit- taking has reduced its cost basis.
The use of technical indicators by investors is the same as used by many speculators. The difference is that the investor makes decisions with an understanding of the value of the assets being purchased.
Investing in a balanced portfolio is a lot of work when the portfolio consists of 20 stocks, diversified by industries in order to meet the mandate of covering a broad segment of the market – even if that segment is narrowly defined as natural resources.
With our natural resources portfolio, we must deal with extreme volatility in commodity prices and the prices of the company stocks. When it’s good, it’s great. Friday was not so great. Our problem is in trying to minimize the drawdowns that will always occur if we hold positions for many weeks and months. Drawdowns are going to be a problem for any capital owner or manager; but the risk management process is much harder with natural resources than say S&P100 or Nasdaq100 stocks.
The question of using stop loss orders to reduce drawdowns is an issue that frequently comes up for discussion. Many people use them; however, we see stop loss orders as mostly a solution for speculators. If we believe a company is failing, we sell the stock. Until then, after further research and analysis, we buy into weakness if we still believe the company’s fundamentals are peer group leaders.
In our portfolio, for example, we hold the shares of natural gas producer Gulfport (GPOR). At the time of writing this article, GPOR shares in the past week alone have plunged some -28%, down from a recent high of about $13.25. However, because we see the entire energy complex including all the natural gas producer stocks getting sold off and we still have GPOR ranked #111 for Growth Stocks and #311 for Value Stocks out of 3814 investment-worthy companies trading in international markets, we decided against a stop loss. In fact, we bought more at $9.53.
Although it’s fair to say we are surprised so far on GPOR, we like the Natural Gas market, as we do for Crude Oil, believing a $4-handle will happen within 14 months (including next winter’s seasonal play as well). For now, in about four days this week, the NG futures price has been smashed from ~$3.25 to ~$2.85 (see chart below), largely because of a short-term bounce in USD in a much longer 13-month period of Dollar weakness. The USD (DXY) popped up a tad late this week; however, buyers of commodities and natural resource stocks have over-reacted, which has fed the computer algorithms that have market price directional control.
Such volatility is not uncommon in the market’s commodity segment. In 4Q2017, during rising natural gas commodity prices, we did make solid profits on two other nat gas stocks, one a company known to many as best-of-breed and the other also a solid contender. We sold them after their relative fundamentals, while still relatively good, had been dropping. This week, our analysis of the relative fundamentals of growth stocks and value stocks shows the one is at #248/514 and the best-known one is #486/1011 out of almost 4,000 companies, so we decided to book profits with these two.
Our natural resources fund closed January fully invested with 19 stocks in 10 industries. We now have interests in oil, natural gas, oil & gas refining, frac sand, uranium, solar, copper, gold, silver and wood. Unfortunately, the January performance declined -1.05% versus a +2.2% gain for the IGE benchmark. In addition to the Gulfport holding, that deficiency is due to the fact (a) we held a high level of cash for most of the month when prices were rising, anticipating a pull-back in prices after very bullish markets through 4Q2017, and which started near the end of the month, and (b) we also took a large position in RPC Inc (RES) believing that oilfield equipment & services companies would benefit from increased capex in the oil & gas industry following the 4Q2017 rise in crude oil prices. But, RES reported disappointing earnings and the shares sold off following lower natural gas prices. Over the month, RPC Inc and Gulfport shares each dropped over -20%, which, along with 30% cash weighting at most times, explains the fund’s under- performance.
But RES is ranked #28 out of 3814 stocks for Growth in our fundamentals screen, so we maintained our investment positions in that stock as well. For the rest of 1Q2018, we believe that despite the events of Friday that the USD will continue its weakness, inflation indexes will continue to rise, infrastructure capex will expand, and the recent high rate of global economic growth is sustainable, which ought to lift the prices in the natural resources segment of the market.
With Oiler companies down today on average -4.9% and Goldminers down -4.3%, with the Dow index down about -665 points, one expects a large drawdown for even the best constructed portfolios, which is what we experienced. At the end of the day, however, we think investment principles and a strict discipline are required for us to call ourselves investment professionals.
We will continue to invest only in stocks of companies that are valued primarily based on how much growth we see today or within a year or two in their future. In the meantime, we understand that price is not always reflecting value. Our job is to exploit the differences.
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