Challenging Times for Investors

Last week the S&P500 made another modest jump higher. With most of the advance occurring on one day, the S&P closed up 1% by the end of the trading week. Volume was light, and volatility—as measured by the VIX index—dipped down to levels not seen since 2014. This is an amazing situation:  as investors push stock prices in the US reach to all-time highs, these same investors are buying very little insurance against potential losses from these all-time highs. Most investors are throwing caution to the wind and believe that stock prices simply can not fall, at least not by much.

So in terms of technical analysis, prices are even more stretched than they were last week…..on both the daily and the weekly chart resolutions. And in terms of broad, long-term valuation measures (measures that are more stable that the simple P/E ratios because E, or earnings, is so volatile), prices are near multi-decade highs.  The price-to-sales ratio, the price-to-GDP ratio, and the more stable Shiller PE ratio are all clearly screaming that the bull market that started in 2009 has pushed valuations to levels that have been attained only a tiny percentage of the time (in terms of weekly closes) in the last hundred years. And every time this has happened in the past, future (or prospective) returns from those stretched valuations have not only been dismally low, but they’ve usually translated into losses over the shorter (one to five year) horizons.

One of the unfortunate consequences of this run-up in prices, is that anyone—professional or not—who’s been the least bit concerned about normal pull-backs in equity prices (or even more serious drops such as an emergence of another bear market) has been brutally punished in terms of performance results. Historically, it almost always paid off, in terms of investment performance, to protect against downside movements in equity prices, typically with hedges in the same asset class (equities) or by owning assets that are negatively correlated with equities (such as US Treasuries).  But in this latest bull market move, the most successful strategy has been to be 100% long US stocks, with no hedging. Even better–you could beat the stock market if you levered up by borrowing money to buy even more stocks; very risky, but this has worked for the relatively small percentage of money managers who’ve done it.

What has this meant for those who have not done this—simple: poor performance. For example, in the world of US hedge funds, where some of the smartest and most experienced money managers do their work, about 90% of them have under-performed the S&P500 since 2009. Yet another example is Harvard University, which boasts of having the largest university endowment in the country—Harvard’s endowment recently reported a 2% loss for the fiscal year 2016. What’s worse, the size of Harvard’s endowment at the end of fiscal 2016 ($37.7 billion) was essentially unchanged from where it stood at the end of fiscal 2007 ($37.4 billion). That’s nine years of no net growth, despite employing an army of the best and the brightest money managers in the world!

Of course, this situation will change at some point, but until it does, the challenging times for investors may continue for a bit longer.

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