Fundamental Investing No Longer a Viable Strategy

X-Factor Report 06 July 2014

by Lance Roberts, Streetalk Live

I am often asked why I focus on technical investment strategies so much in my writings. It is a good question to which there are two specific answers.

1. Fundamentals are important in “very” long term investing where the average hold time for an investment is at least five years or longer. The reason is that fundamental underpinnings are very slow to change and only have an impact on “long-term” returns.
2. There is a “duration mismatch” between fundamental investing and investor expectations. As stated, using fundamental analysis to make long-term investment decisions requires a hold period of five years or longer. Individuals focus on returns that are one year or less. The only investment strategy that works on a very short time frame is technical analysis that focuses on short-term price trends and momentum.

The following excerpt from the Wall Street Journal confirms this view.

“Steve Eisman, who emerged as one of the stars of the financial crisis with a winning bet against mortgages, is shuttering his hedge-fund firm, according to people familiar with the matter.

Mr. Eisman’s profile grew at the hedge-fund where he previously worked, FrontPoint Partners, which was once owned by Morgan Stanley and where he had managed more than $1 billion. Besides his bet against mortgages, he was known for shorting, or betting against, for-profit education companies and lobbying against the industry in Washington. He was featured in the best-selling book about the financial crisis, ‘The Big Short.’

In a May regulatory filing, the firm wrote it believed that “making investment decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy.”

Instead, Emrys echoed what many stock pickers have said in recent years about larger factors affecting their ability to invest as they had historically. ‘While individual company analysis will always be important,’ it said, ‘the health, or the change in the health, of the financial system is the starting point of all analysis.'”

The legendary investor Seth Klarman of Baupost Capital also stated:

“In the face of mixed economic data and at a critical inflection point in Federal Reserve policy, the stock market, heading into 2014, resembles a Rorschach test. What investors see in the inkblots says considerably more about them than it does about the market.

If you were born bullish, if you’ve never met a market you did not like, if you have a consistently short memory, then stock probably look attractive, even compelling. Price-earnings ratios, while elevated, are not in the stratosphere. Deficits are shrinking at the federal and state levels. The consumer balance sheet is on the mend. U.S. housing is recovering, and in some markets, prices have surpassed the previous peak. The nation is on the road to energy independence. With bonds yielding so little, equities appear to be the only game in town. The Fed will continue to hold interest rates extremely low, leaving investors no choice but to buy stocks it does not matter that the S&P has nearly tripled from its spring 2009 lows, or that the Fed has begun to taper purchases and interest rates have spiked. Indeed, the stock rally on December’s taper announcement is, for this contingent, confirmation of the strength of this bull market. The image is unmistakably favorable. QE has worked. If the economy or markets should backslide, the Fed undoubtedly stands ready once again to ride to the rescue. The Bernanke/Yellen put is intact. For now, there are no bubbles, either in sight or over the horizon.

However, if you have the worry gene, if you are more focused on the downside than upside, if you are more interested in return of capital than return on capital, if you have any sense of market history, then there’s more than enough to be concerned about. A policy of near-zero short-term interest rates continues to distort reality with unknown but worrisome long-term consequences. Even as the Fed begins to taper, the announced plan is so mild and contingent – one pundit called it ‘taper-lite’ – that we can draw no legitimate conclusions about the Fed’s ability to end QE without severe consequences. Fiscal stimulus, in the form of sizable deficits, has propped up the consumer, thereby inflating corporate revenues and earnings. However, what is the right multiple to pay on juiced corporate earnings? Pretty clearly, lower than otherwise. Yet Robert Schiller’s cyclically adjusted P/E valuation is over 25, a level exceeded only three times before – prior to the 1929, 2000 and 2007 market crashes. Indeed, on almost any metric, the U.S. equity market is historically quite expensive.

A skeptic would have to be blind not to see bubbles inflating in junk bond issuance, credit quality, and yields, not to mention the nosebleed stock market valuations of fashionable companies like Netflix and Tesla. The overall picture is one of growing risk and inadequate potential return almost everywhere one looks.

There is a growing gap between the financial markets and the real economy.

Six years ago, many investors were way out over their skis. Giant financial institutions were brought to their knees…

The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.

However, here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.

Can we say when it will end? No. Can we say that it will end? Yes. Moreover, when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.

A Few Simple Reminders

It is from that last statement that Ben Carlson, via A Wealth Of Common Sense, wrote these simple reminders that we should all remember:

Some simple reminders about what to focus on:

1. Portfolio management not investment strategies.
2. Meeting your needs & desires not beating benchmarks.
3. Risk management not risk measurement.
4. Long-term process not short-term outcomes.
5. Products you understand not investments that sound intelligent.
6. Important not urgent.
7. Simplicity not complexity.
8. Think opportunities not volatility.
9. Fewer decisions not more choices.
10. Enough not more.
11. Delayed gratification not instant.
12. Systems not willpower.
13. Flexibility not certainty.
14. Evidence not opinions.
15. Humility not hubris.
16. A plan not tactics.
17. Emotional control not hedging.
18. Patience not activity.
19. Balance not gambling.
20. Perspective not more information.
21. Investing not speculation.
22. Total return, not just yield.
23. Discipline not neglect.
24. Your time horizon not someone else’s.
25. Books not arguments.
26. Moreover, finally, remember that financial independence is about time not wealth.

With those thoughts in mind, enjoy the rest of your holiday weekend. I have a sneaky feeling that “fireworks” in the markets may not be too far away.

“I hope we once again have reminded people that man is not free unless government is limited. There’s a clear cause and effect here that is as neat and predictable as a law of physics: as government expands, liberty contracts.” Ronald Reagan.

“When plunder has become a way of life for a group of people living together in society, they create for themselves in the course of time a legal system that authorizes it, and a moral code that glorifies it.” Frédéric Bastiat.

See you next week.