Friday’s Random Thought

My 3 p.m. meeting was cancelled today, freeing up some time for me to catch up on some reading.  While perusing my bookmarked financial blogs, I came across a quote (from a money manager whom I hold (held) in high regard) that made me stop in my tracks.  So much so that I had to re-read the paragraph three times to make sure I wasn’t missing something.  I’ll leave the manager’s name out of this discussion, but here is the quote:

“As a money manager, my portfolio model remains currently fully invested. The problem is that I am grossly uncomfortable with that allocation given the risks that currently prevail. However, as I have stated many times previously, I must follow the trend of the market or I will suffer “career risk” as clients move money elsewhere to chase market returns.”

How can so much “wrongness” be packed into one short paragraph?

  •  “…my portfolio model remains currently fully invested” and “I am grossly uncomfortable with that…”  That’s kind of like a doctor who keeps prescribing a medicine, even though he knows the prescription is elevating the risk of an adverse reaction or death.  I think I’d ask for a second opinion!
  • “I must follow the trend of the market…”  Here’s a tip from one money manager to another:  VFINX follows the “trend of the market” quite nicely; and does it for 0.17%.  What are your management fees?
  • “I will suffer ‘career risk’ as clients move money elsewhere to chase market returns.”  Career risk?  Seriously?  One of the things I learned early on in my career was that longevity was much more likely when you put the clients’ best interests ahead of your own.  Sometimes that means taking a call in the evening or on a weekend.  Sometimes it means driving out of your way when the client needs to meet you at their convenience.  But ALWAYS, ALWAYS, ALWAYS it means treating their money with as much care as you treat your own.  And, unless you’re insane, you are not likely going to invest your own money in a way that exposes it to known or perceived risks.  Besides, I must have glanced over the part of the contract where the clients signed up to be my personal annuity.

Those who know us know we manage money in an uncorrelated fashion with an eye on consistency of returns.  Following the trend is not our thing.  As such, we’ve had clients leave us since 2009.  It started with some of our wholesalers for whom it was easier to replace us with the “hot dot” than to have a serious discussion with the end client about where we fit in terms of risk and reward.  Other clients stayed for a few years more, but ultimately succumbed to the Sirens’ song of seemingly riskless riches.  I maintain friendships with many of those who left, as I understood that everyone is driven by their unique emotional makeup, there was nothing personal about their business decision, and I wasn’t going to change the way we manage money.

Fortunately, we adjusted our business in anticipation of expected redemptions.  We reduced our cost structure, moved our broker/dealer relationship to a more efficient chassis, entered into new market segments, and brought in a second portfolio manager to help insure that our investment process and security selection was as good as it could be.  We also recognized that, in a persistently rising market, we had to strip costs to the client down to the minimum.  So that’s what we did.

Now, five years later, we’re as healthy as we’ve ever been.  Our client base has been diversified.  We learned to be more efficient.  Our clients enjoy lower costs.  We have a new and experienced portfolio manager/business partner.

It’s ironic that, because we chose to embrace “career risk, ” we’ve become a better organization.

Still, it makes me wonder how much of the stock market rally can be attributed to the mentality expressed by that money manager/blogger.  I fear it’s more than a little.  When the fire alarm sounds, there are going to be a lot of people trying to get out of too few exits – not so good for the clients, but at least many careers will remain intact. – LL


The Grateful Dead and Noise Pollution

We started this business in 1992. Back then it was known as Bayfield Financial, then we took on some partners and changed the name to Irvin/Letterio Portfolio Management.   After that, we took on more partners and became Peregrine Advisers, subsequently sold the company to private equity, did a public offering, followed by a management buyback, ultimately becoming Altair Management Partners.

Over those years, we enjoyed the 1990’s tech bull market, endured the tech bubble popping, coasted along with the housing bull market, navigated the Great Recession, and marveled at the subsequent Fed-induced bull market.   We look back grateful that our flagship investment strategy never suffered a decline greater than single digits.

What a long, strange trip it’s been.

In a way, our longevity was helped along by doing our own research, having a distinctively contrarian viewpoint, and (most importantly) being able to glean causality from the events unfolding before us.

Which is what brings me to write this post.

For most of 2014, I’ve been witnessing things to which I cannot confidently attribute causation.   To wit, implied volatility (VIX) sits at 11.65; a full 19%+ below its level just one year ago.   At the same time, the S&P 500 melts upward to low volume all-time-highs.   All of this while the yield on the 10-year Treasury fall to 2.44% (a 15.6% decline in yields since the beginning of the year), and the yield curve continues to flatten.

So, bonds are rallying, stocks are rallying, volatility is practically non-existent, the yield curve is flattening and the Federal Reserve is backing out of bond purchases.   Strange bed-fellows.

I’ve picked my brain for the past few weeks trying to find a similar set of historical circumstances from which to glean some insight.   I’ve also been looking at foreign bond prices and currency pairs to assess the possible impact of the carry trade (which looks pretty possible).   I’ve dug through economic releases looking for inflation, stagflation, deflation, or disinflation (mixed bag, at best).   I’ve read bullish narratives (which sound like talking points), bearish narratives (which always sound too smart by half, which makes me dubious), and conspiracy narratives (for entertainment after reading all the dry material).

The takeaway for me is that I simply cannot explain the coincident movements in these indicators.   They seem counter-intuitive.   On a certain level they seem irrational.   They come across to me as so much noise.

When I say “noise, ” I mean a very specific kind of noise.   Let me give an example.   In instances where we employ third party managers, the dominant reason we terminate them tends to be noise.   It’s that unexplainable change in the way the manager is communicating, researching, staffing, or responding to inquiries.   It’s subtle, it’s often gradual, and it’s far more noticeable through intuition than through dogmatic questionnaires.   It’s one of those things you can’t quite put your finger on, but your intuition hears it.   It’s noise.

Over the past 22 years, we’ve had some luck factor into our achievements; but analysis would show that the single-most important factor was avoiding two major bear markets by our willingness to walk away when we heard the noise.    Simply put, if we can’t understand what we’re hearing we won’t invest in it.

Now, I wish I could provide some awesome technical and fundamental analysis for the reason we’re beginning to flatten out our exposures.   But as I said earlier, I can’t.   I can’t, because I can’t hear very well.   There is just too much noise. – LL


Hey Michael, We Missed You But We’re Glad You’re Back

While doing the tour to promote his new book “Flash Boys, ” Michael Lewis showed up today on CNBC with the star of his story in addition to  the head of BATS.  What transpired was pure tragicomedy.  While the Lewis team mounted a full frontal attack against the High Frequency Trading machine, the dude from BATS went apoplectic.

I’ve read Lewis’ book and agree with many of his findings.  It’s well-written, taken from a unique perspective, and well worth the $10 Kindle price.  But I have to ask:  What took you so long Michael?

HFT has been the bane of traders’ existence for many years now.  We’ve been squawking about it since 2011.  See:

Hard stop on the shameless self-promotion.

Anyway, here is the clip from CNBC for your viewing pleasure.




You’ve Got the Teeth of a Hydra Upon You

I’m not known as a technical analyst (although I play one on TV).  Yet, today’s blog post is a technically-oriented look at the three-headed Hydra that emerged during today’s trading.

Head #1:  At nearly the precise moment when the yield on the 10-year Treasury matched the dividend yield of the S&P 500, the market began an accelerated decline.  Due to the volume and speed with which the decline occurred, one can probably attribute it to our friend the robot.  If this relationship persists, it could spell a bearish omen for stocks.

Head #2:  Today we witnessed the dreaded Bearish Engulfing Outside Reversal.  Put simply, the BEOR occurs when today’s high and today’s low exceed the highs and lows of yesterday’s trading.  If you’re charting in candlesticks, today’s candlestick has a higher top and a lower bottom than did yesterday’s.  Often, this portends a reversal in the direction of the market.

Head #3:  From Doug Kass…  The last two times the S&P 500 hit an all-time high and closed more than 1% from that high were 10/11/07 and 3/24/00.  Things got a little interesting after each of those dates.  Today the high was achieved at 10:29 a.m. with the S&P touching 1687.18.  By the close, the S&P had settled at 1655.34 — a decline of nearly 1.9%.

Taken individually, each of these Hydra Heads could be nothing more than interesting data points.  But when all three occur on the same day, my antenna goes up.

As for why this happened, I can try to glean causation out of correlation.  The market seemed to move in concert with the prevailing winds of the Federal Reserve’s signalling the tapering of POMO or not.

It now looks like we’re in a taper-on/taper-off market.

The robots are going to be quite busy.

Get it on, bang a gong.  – LL


Happy Anniversary Baby, Got You on My Mind

I remember it well.  It was 25 years ago October 19.

  •  The Bangles were walking like Egyptians.
  • Gordon Gekko was slapping Bud Fox around in the park.
  • Mr. Belvedere was cancelled by ABC.
  • Reagan was at the Berlin Wall, punking Gorbachev.
  • Coked-up/coke-dealing stockbrokers were being arrested around the country.

1987 was one hell of a year.

25 years ago today it was Black Monday… the day the stock market had its largest single day percentage loss in its history.  In one day, the market fell 22%.

On that day, I was 59 days into my new career with a regional broker/dealer.

My personal remembrances from that day remain somewhat fuzzy – a mishmash of extreme emotions and mind-bending fatigue.  The day started with a sense of foreboding, since the market had lost 108 points on the Friday prior.  Before our markets opened, Singapore had dropped 33%, Tokyo was down 17%, and Hong Kong had dropped by 11%.  London was down 22%; Frankfurt was down 13%.

90 minutes before the market opened, the phones were ringing.  A lot.

I hadn’t yet sat for my Series 7 exam, so I was not in a legal position to offer investment advice to the callers.  Yet the calls were so numerous that everyone, including me, was picking them up as best as we could.  The company line was “tell the investors to stay the course” and that’s precisely the advice we offered.

Not that it mattered all that much.  At least half of our clients were in open-end mutual funds that wouldn’t be priced for redemption until the end of the day.  Most of the rest were in 3rd party managed accounts (wrapped at 3%, I might add) over which the investor had no discretion.  For those investors, it was going to be a day of watching a video-taped train wreck one painful frame at a time.

When the market opened, things weren’t as bad as we expected.  A bit of cautious optimism began to seep into the office as normalcy bias was on full display.  In retrospect, those feelings were terribly unwarranted – the opening was only moderately weak due to the fact that many stocks had failed to open immediately while their investors were being warned of the impending opening prices.

Once all stocks opened, things got bad.  Later in the morning, things got really bad.

And, being 1987, technology was not what it is today; particularly for small firms like ours.  Order flow in the markets was so extreme, getting a price for placing a sell order was impossible.  A market order, for those desperate to sell, might sit for an hour or more before being executed at an unknown level.

The noise, both physical and mental, was nearly deafening.

There are no patterns in a panic.  A desperate search for information, a desperate crush of fruitless client-assuaging calls, and a desperate on-going attempt to measure the damage.  All these acts being performed randomly by random employees.  “Fire in the movie-house” style.

By the time the carnage was over, the market closed 508 points lower.

I think everyone sat in the office that day until well past 10 p.m.  We really weren’t doing anything productive.  The phones had stopped ringing and the TV’s were shut off.  At the time, most of us were in our mid-20’s; children in terms of stock market experience.  We were feeling like the unlikely survivors of that frame-by-frame train wreck – wandering around zombie-like, with no real sense of what to do now or what was to come tomorrow.

The pervasive emotion I recall at that time was numbness.

By the time I left for home that Monday, I was stepping over Tuesday’s morning paper that was resting by the front door of our office.

Taken in a context larger than that of a regional broker/dealer and a 20-something new hire, Black Monday was the culmination of many factors that converged in a short period of time:

  • By August 25, 1987, the Dow had gained 43% for the year.
  • Before the Crash, 158 companies had split their stocks on the NYSE alone.
  • “Portfolio Insurance” was a popular way to limit your losses.
  • Takeovers had been so prevalent earlier in the year, on October 14th there were open discussions about applying a punitive tax on takeover profits.
  • Germany and the US were verbally engaging in a currency war, culminating with Treasury Secretary James Baker appearing on the Sunday talk-show circuit saying outright, “Either inflate your Mark, or we’ll devalue the Dollar.”  This was October 17th.
  • On September 9th the newly sworn in Fed Chief, Alan Greenspan, made a pre-emptive strike on inflation by raising the discount rate by 50 basis points.
  • On the back of record high trade deficit figures, the Prime Rate spiked on October 15th and the bond market began to collapse.
  • On October 16th a rare hurricane hit London, forcing their market to close and sending European investors seeking liquidity to sell in New York.
  • In the midst of the Black Monday morning, a rumor circulated that the SEC was going to halt the market.  This only accelerated the selling.

Hindsight makes the Crash (at least its probability, if not its magnitude) seem like it should have been expected.  But clearly, that wasn’t the case.

When the smoke cleared and the analysis began, it became apparent that the day following Black Monday had the potential to make Monday look merely like a warm-up.  Banks were no longer willing to accept stock as collateral for their short-term loans to market makers.  Liquidity was sucked from the system, stocks began to crash and be halted, and indexes tumbled.  The day after the worst day ever was beginning to look catastrophic.

In the end, the Fed ultimately intervened, instructing the banks to step up and provide liquidity.

Stocks closed in positive territory on record volume (608, 120, 000 shares) that Tuesday.

On October 21, the market saw its largest one-day percentage gain since 1933, tacking on 10%.

As a newbie, the events of those two days forever shaped my perception of risk.  When this company was founded over 20 years ago, systemic risk management was a central theme.  It remains so to this day.