Best of 2014: Taking Stock of the Year in Equities
Early in 2014, Federal Reserve Bank of Dallas president Richard Fisher acknowledged, “There are increasing signs quantitative easing has overstayed its welcome . . . Stock market metrics such as price to projected forward earnings, price-to-sales ratios, and market capitalization as a percentage of GDP are at eye-popping levels not seen since the dot-com boom of the late 1990s.” As the year progressed, value investor Seth Klarman observed, “We really are far along in re-creating the markets of 2007.” The warnings of these market veterans have thus far gone unheeded by most investors and, as of this writing, US equities are on pace for another year of double-digit gains. Stock markets in China and Japan have also moved higher, while major markets in Europe have been mostly flat, and emerging markets have lagged.
Looking ahead, we expect equity investors to continue to take their cues from central bankers. As monetary policy in Asia and Europe is loosened further in an effort to spur sluggish economies, the Fed is contemplating an end to its zero interest rate policy amid signs of accelerating growth in the United States. A less favorable interest rate backdrop for investors in US stocks will almost certainly require them to become more discriminating buyers. This may signal a renewed focus on fundamentals and a comeback for stock pickers, and calls to mind Warren Buffett’s quip, “you only find out who is swimming naked when the tide goes out.”
Below I highlight some of the best equities-related content I came across over the past year, as well as some of my favorite quotes. Best wishes for the New Year.
Active vs. Passive
The struggles of active managers have been well-chronicled throughout 2014. In the United States, fewer than one in five active fund managers were beating the market this year through October, their worst showing in over a decade. In response, and as evidenced by fund flow data, investors are adopting a passive approach in increasing numbers. Charley Ellis, CFA, thinks this trend is unlikely to reverse, arguing that when it comes to active investing, the “party is over.” Cambridge Associates, however, found that certain active managers can still deliver alpha.
Activist investors, those who target underperforming companies and lobby for change, can also make a difference. That’s the conclusion of a McKinsey & Company study, which found that “the median activist campaign reverses a downward trajectory in target-company performance and generates excess shareholder returns that persist for at least 36 months.”
The CAPE Debate
It was just about a year ago that the pseudonymous blogger Jesse Livermore delivered a well-reasoned argument that the cyclically-adjusted P/E metric popularized by Nobelist Robert Shiller is flawed, and boldly predicted that valuations had likely reached a “permanently high plateau,” echoing the ill-timed words of Irving Fisher in 1929. This post elicited a flurry of rejoinders over the ensuing months, and two of the best came from GMO’s James Montier and Morningstar’s Samuel Lee.
This year companies in the United States have been repurchasing shares on a scale only exceeded in 2007, prompting many to ponder whether this has been the best use of capital. Data suggests that companies have lousy timing when it comes to stock buybacks. In “Profits Without Prosperity,” William Lazonick argues that buybacks — undertaken in the name of enhancing shareholder value — have diverted capital from more worthwhile investments and, as a result, innovation has suffered, growth has been stunted, and employees have been left behind. Montier agrees that the buyback binge is, in part, a result of “managerial short-termism” and the misplaced ideal of shareholder value maximization, something he calls “the world’s dumbest idea.” Are buybacks always value destroying? Certainly not, as Aswath Damodaran makes clear in his balanced analysis of share repurchases. He notes that “the notion that more reinvestment by a company is always better than less is absurd.”
Future of Finance
In “The Price of Wall Street’s Power,” Gautam Mukunda argues that prudent decision making by company management is too often undermined by Wall Street’s “outsize influence” and obsession with meeting short-term financial targets. What’s the remedy? In “Curbing Short-Termism in Corporate America: Focus on Executive Compensation,” Robert Pozen calls for longer time horizons in management incentive packages and an end to quarterly earnings projections.
In “The Case for Long-Termism,” Keith Ambachtsheer argues that a long-term investment perspective is good for society and for those investors willing and able to practice it. And Ashby Monk, in “The New Dawn of Financial Capitalism,” says our financial system is being undermined by complexity, greed, and short-termism, and calls for a more sustainable version of capitalism.
Finally, William Cohan’s account of the price paid by Wall Street whistleblowers is a stark reminder that, when it comes to restoring trust in our industry, there remains much work to be done.
The world of finance is filled with (mostly) smart individuals who are rarely at a loss for words, sometimes to their own detriment, but almost always to our benefit. Below are some of my favorite quotes from 2014.
- “You can sometimes be a successful money manager without reading up on monetary economics.” (New York Times columnist Paul Krugman on AQR’s Cliff Asness)
- “Responding to Krugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like many unpleasant tasks, it’s necessary.” (Asness on Krugman)
- “Our industry is full of people who are famous for being right once in a row.” (Howard Marks at the Equity Research and Valuation 2014 conference)
- “If the [Harvard Business Review] talks about valuation and investing, you can safely assume that it is either wrong or misdirected.” (NYU Stern School of Business professor Aswath Damodaran)
- “Selling options today is like picking pennies in front of the steamroller.” (GMO’s Marc Seidner on historically low volatility)
- “Ben Graham had a lot to learn as an investor.” (Berkshire Hathaway vice-chairman Charlie Munger)
- “FHFA is also working with [Fannie Mae and Freddie Mac] to develop sensible and responsible guidelines for mortgages with loan-to-value ratios between 95 and 97 percent.” (Melvin Watt, director, US Federal Housing Finance Agency)
- “I want to buy Alibaba on Friday, whatever the price.” (Hair salon owner Fabio Doti on the Alibaba IPO)
- “I think I’ll buy a few hundred shares of it . . .The only thing I know about it is the hype.” (Retiree Bob Lewis on the Alibaba IPO)
- “If I can’t have a monopoly then, at a minimum, I want an oligopoly.” (Sam Zell on business at the 2014 Financial Analysts Seminar)
- “Bitcoin isn’t an investment, it’s a slot machine. Or, more accurately, a loaded roulette wheel.” (Jeffrey Robinson, author of Bit Con: The Naked Truth About Bitcoin)
Equity Research and Valuation 2014
Along with the Boston Security Analysts Society, CFA Institute hosted the Equity Research and Valuation 2014 conference in November. Speakers included valuation expert Aswath Damodaran; Oaktree Capital’s Howard Marks, CFA; and Fidelity’s Joel Tillinghast, CFA. Highlights from the conference can be found on its Twitter stream, and I encourage you to consider attending next year’s conference in Philadelphia.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.