“I figure lots of predictions is best. People will forget the ones I get wrong and marvel over the rest.” - Alan Cox
Early June, one of the greatest heavyweight fighters and prognosticators of all time passed away – Muhammad Ali. Ali never shied away from a microphone or the spotlight. He was a shrewd promoter who knew how to incite boxing fans and his opponents into a frenzy. His eloquent pre-fight predictions were poetic. “They must fall in the round I call”, the boxer famously shouted. Once Ali became champion, he admitted that predicting the round in which he would win a bout was just a way of drawing attention to himself as a young fighter.
The surprising thing is that there is no accurate record of the results of his pre-fight predictions. He did get a few correct early in his career, but nobody remembers exactly how many times he was wrong. In this way, predicting fights is very similar to predicting stock market levels. Most people will not remember if a prediction is incorrect, so everyone seems to keep on making them…there is no downside, no consequence. This fact is what distinguishes market prognostication from investing. Investing has a clearly accurate track record.
Investing has consequences. Especially if you are wrong.
As US equity indices once again approach record levels, the investment media has become obsessed with stock market related predictions. Can the S&P 500 Index get to 2,200? Will the Dow Jones Industrial Average reach 18,000?
In late 2014 and throughout 2015, when the price of a barrel of oil was falling from the $100 level, seemingly every market participant had an opinion as to exactly where the price of oil would fall to and then provide rationale supporting their predictions (by the way, I do not recall $25 as one of those projections). As interest rates decline below zero, bond fund managers are asked the same types of questions: How low can interest rates go? How long will rates stay low?
History has proven time and again, attempting to answer these questions is an exercise in futility. Nobody knows where the markets or interest rates or the price of oil will be in the future.
Anecdotally, the S&P 500 Index is trading near all-time highs. At the same time, the 30-year US Treasury bond is trading at all-time highs (high prices; and record-low yields). There are currently $10 trillion of negative yielding bonds trading globally today (wrap your brain around that statistic for a second) and central banks in Europe just started buying high yield bonds.
Within this financial market context, from a risk/reward standpoint, short-duration, high quality corporate bonds and cash are probably as appealing as they have ever been (mainly low risk, not high reward). Patience might also be as valuable as it’s ever been. High equity valuations and low interest rates both portend potentially low investment returns…unless, of course, global economic and corporate growth rates increase soon.
The Nedgroup Investments Global Cautious Fund’s investable market is generally lumped into three major categories – equities, investment grade bonds (including government bonds) and high yield bonds. Interestingly, all three groups have gone up over the past few months. Persistently low government bond rates are supporting high yield bond and stock prices. Our contention is that at some point, something among these three groups has to give. Either the world will grow sufficiently enough to support current equity market valuations and high yield credit spreads, forcing a decline in bond prices and higher interest rates; or growth will falter to justify interest rates at record lows, forcing equity prices to fall and corporate credit spreads to widen.
We will refrain from making any prediction as to which outcome will occur. But we will patiently (and eagerly) await the opportunity that is created from either of these outcomes. If alternatively, all three groups of securities continue to rally; our expectation is that the fund’s cash position could become a drag on performance, as it has been during the first two months of the second quarter.
As managers of the Nedgroup Investments Global Cautious Fund, it is our contention that over the long term one cannot consistently and accurately predict events in the stock or bond markets any better than a person can consistently and accurately predict which round a heavyweight championship fight will end. The markets (and boxing matches) contain a wild card – human emotion and behaviour. This behaviour is driven by fear, greed and expectation. These intangible, non-measurable factors make the markets inconsistent and unpredictable, especially in the short term. In terms of a prediction, the only one we are willing to stand behind is that the markets will rarely be efficient in the short term. Any other prediction outside of this context is not a prediction at all… it is a guess.
Our investable market is very broad, extending across virtually all equity and fixed income sectors. As a result, we get questioned regularly regarding our opinion of market levels. We do our best to respectfully oblige the request by giving our view from the bottom-up. However, it is clear most times that the questioner is not completely satisfied with our answer. At times it feels like we are speaking two different languages. The truth of the matter is that we do not waste time thinking about where the S&P 500 Index is trading from a price standpoint or where the index will be in a year from now.
All we care about is finding value... in any market environment, no matter what circumstances are presented to us. Our bottom-up view of the market will be obvious to shareholders through the fund’s asset allocation. If the fund is fully invested, it should be clear that we are finding ample amounts of opportunity relative to risk. If the fund has a big allocation to cash (like the fund has today), our bottom-up view, in aggregate, is that the amount of risk required to hold securities in our investable universe exceeds the benefit or the potential reward. It really is that simple. Our opinion will always be the same. We want the markets to present us with value and we will go wherever we identify this value on a security by security basis. Like Ali, we will attempt “To float like a butterfly and sting like a bee”.