Tuesday, August 6, 2013

Is The Smart Money Getting Out?

Robert Farzan of Bloomberg reports, Is the Smart Money Getting Out?:
As markets break all time highs, there are signs that the smart money, as it’s called, is keen to get out.

Data compiled by Bank of America Merrill Lynch show that institutional investors have been net sellers of stock since late June, while retail clients have been net buyers since early June (their longest buying streak since late 2011). The blog ZeroHedge quipped: “So it would appear the ‘real’ great rotation is passing the hot-potato of liquidity-driven stocks from the ‘smart’ money to the ‘dumb’ money once again.”

Bloomberg’s Devin Banerjee took inventory of how buyout shops prefer to sell into the bull market (the Standard & Poor’s 500 index is up 152 percent since March 2009). He reports that the private equity industry’s focus on exits has reduced the volume of leveraged buyouts this year, with the number of deals announced declining 20 percent, to 3,047 worldwide, from the same period last year.

One example is Fortress Investment Group (FIG), which in 2007 became the first publicly traded private equity and hedge-fund manager. Yesterday, Fortress said its second-quarter pretax distributable earnings more than tripled to $148 million from a year earlier. The alternative asset manager, which is busy preparing public offerings, has already exited the remaining investments in its first buyout fund.

“It’s a difficult environment to find really attractive things when the markets are robust as they are,” Fortress Co-Chairman Wes Edens said yesterday on an investor conference call. “This is a better time for selling our existing investments than making new investments,” concurred his fellow co-chairman, Peter Briger. “There’s been more uncertainty that’s been fed into the markets.”

According to Banerjee, in the last quarter private equity giant Blackstone (BX) sold shares in three companies—General Growth Properties (GGP), Nielsen Holdings (NLSN), and PBF Energy (PBF)—and took three public, including SeaWorld Entertainment (SEAS). Blackstone’s second-quarter economic net income of $703 million more than tripled its year-earlier showing. “With credit markets hot and equities strong, this is a better time for selling assets than for buying,” Blackstone President Tony James said on a July 18 call. “Activity levels seem to be shifting from the U.S., which has been our focus over the last couple of years, to Europe, where there’s more distress, and Asia and emerging markets, where liquidity issues are arising.”

Leon Black’s Apollo Global Management (APO), which oversees assets worth $114 billion, made $14 billion in proceeds from the sale of holdings from the first quarter of last year to the first quarter this year. “It’s almost biblical: There is a time to reap and there’s a time to sow,” he said at an April conference. “We think it’s a fabulous environment to be selling. We’re selling everything that’s not nailed down in our portfolio.”
Buyout shops are all taking advantage of hot credit and equity markets to realize on their investments and reap the gains.

The implications for public pension funds are huge. According to a report by Wilshire Associates, U.S. public pensions booked a median gain of 12.4 percent for the 12 months through June, powered by a surge in U.S. stock prices to a record. The funds chalked up an annualized three-year median return of 11.4 percent while their assets surpassed a pre-recession peak to reach $2.9 trillion, according to U.S. Census Bureau figures.

If the rest of the year continues to hum along like the first half, public pensions will continue booking solid gains. However, if Byron Wein turns out to be right, the rest of the year will be a lot rockier and public pension funds heavily exposed to public equities risk experiencing big losses.

John Mauldin recently put out a comment, "Can It get Any Better Than This?," where he notes the following:
To many investors, developed markets appear healthier and stronger than they have in years. Major equity markets are rallying to record highs; corporate credit spreads are tight versus US Treasuries and getting tighter; and broad measures of volatility continue to fall to their lowest levels since 2007.

This kind of news would normally point to prosperity across the real economy and call for a celebration – but prices do not always reflect reality. Moreover, the combination of high and rising valuations, low volatility, and a weakening trend in real earnings growth is a proven recipe for poor long-term returns and market instability.

Let’s take the S&P 500 as an example. It returned roughly 42% from September 1, 2011, through August 1, 2013, as the VIX Index fell to its lowest levels since the global financial crisis. Over that time frame, real earnings declined slightly (down about 2% through Q1 2013 earnings season), while the trailing 12-month price-to-earnings (P/E) ratio jumped 44%, from 13.5x to 19.5x. That means the majority of the recent gains in US equity markets were driven by multiple expansion in spite of negative real earnings growth. This is a clear sign that sentiment, rather than fundamentals, is driving the markets higher.
One sign that sentiment is driving markets higher is that 'low priced' stocks are disappearing:
One way to monitor speculation is to watch low-priced stocks. These are often more volatile and favorites of those who like their stocks a little on the trashy side. The Ned Davis chart below (click on image) shows that low-priced stocks – as represented by the 25th cheapest stock in the S&P 500 – have had quite a run. The current reading of $15.51 is approaching the $16 level that was a warning flag for the last two big market tops.

Single digit stocks are rapidly disappearing from the S&P 500. According to Bloomberg data there are just 8 such stocks in the index today compared to 20 one year ago.

As the table within the chart shows, the S&P 500 struggles when this measure cross the $16 mark.

Be warned!
Another key indicator, the “High Low Logic Index” created by Norm Fosback, editor of Fosback’s Fund Forecaster, is no longer bullish. The indicator represents the lesser of two numbers: New 52-week highs and new 52-week lows (both expressed as a percentage of total issues traded). High readings are bearish, while low levels are bullish. The last time this indicator generated a sell signal was in late 2007, just before the Great Recession.

There are plenty of signs that stocks are toppy which is why bears are at the gate. But as Dave Moenning notes, they may keep losing:
It is also worth noting that the attempts by the bears to derail the bull train have been largely unsuccessful so far this year. Sure, the market paused when Cyprus made headlines. And yes, the "taper tantrum" in May/June did produce a garden-variety pullback of -5%. But beyond that, it's been the bulls' ballgame this year.

In fact, the +18.2% year-to-date gain for S&P 500 through July 31, qualifies as one of the best first-seven-month gains in history. According to the computers at Ned Davis Research, the 2013 gain through July is the best since 1997 and the 11th best since 1929. No wonder the bears are frustrated!

The question, of course, is where do we go from here? The bear camp is howling about another overbought condition and the fact that valuations are beginning to move away from fair value. The glass-is-half-empty gang also continues to moan about the idea that the Fed's ZIRP (zero interest rate policy) is the only thing keeping the indices afloat. Thus, our furry friends contend that the current rally is not going to end well and that we should be bracing for a replay of 2008.

As I've mentioned a time or twenty, we don't play the prediction game at our shop. No, we like to be opinion-agnostic and merely try to stay in line with what the market IS doing at all times. This approach does get us whipped around a bit when the market is in an "iffy" state, but it also keeps us on the right side of the market's really important moves, the vast majority of the time.

However, it is also nice to have some sort of idea as to what to expect next. So, this morning I thought we'd look at the statistics on what strong gains from January through July tell us about the coming months. And then tomorrow, we can revisit the cycle composite to see what the cycles say about August.

Since the end of World War II, a gain of at least 15% for the S&P 500 through the end of July has been a good omen for the rest of the year. Of the twelve times the S&P has put up gains of 15% or more in the first seven months of the year, the market has finished higher at the end of the year eleven times, or 91.7% of the time.

Although the 1987 case skews the stats a bit, the average gain for the following five months of the year after a gain of 15% in the January through July period has been +4.3%. And if we take out the 1987 program trading-induced disaster, the average increases to +6.7%.

However, in doing the math one thing jumped out at me. Over the August through December periods, the gains tended to be either small or significant. For example, of the eleven cases we reviewed where the market finished higher after a strong seven-month start, the S&P finished the ensuing five months higher by less than 2% on five occasions. And for the six cases when the market was stronger during the August-December period, the average gain has been nearly +11%. In other words, after a strong gain in the first seven months of the year, history shows the bulls either continued to romp - or - limped home into the end of the year.

On a near-term basis, the stats are less conclusive and also less encouraging. Since the end of WWII, the S&P has only been higher during the month of August 42% of the time and has only been higher three months later one-half of the cases. Thus, in short, it looks like August could be a toss-up.

However, looking longer term, the first seven-month surge appears to have lasting benefits for those holding stocks. Since 1929, the S&P 500 has been higher over the next six months 72% of the time. And then looking out a year, the market has finished higher 83% of the time since the end of WWII and sported an average gain of nearly 12% during the period.

To be sure, history rarely, if ever repeats. However, in the markets, history often rhymes with near-term events. As such, it appears that if the bulls can muddle through that last summer month, they could be rewarded going forward. Granted, the pace of the gains is likely to slow. But the key is that if history can repeat to some degree, the bears may continue to be frustrated.
Will the bears continue to be frustrated? Nobody knows. All I know is that pension funds should review their asset allocation, focusing on mitigating downside risks. Betting big on hedge funds and  increasing allocations to private equity, real estate and infrastructure might pay off, but it exposes pension funds to illiquidity risk. Others are taking a smarter approach to protect their gains.

Below, Dan Wiener, CEO of Adviser Investments and SJ Consulting President Satish Jindel discuss their investment strategies with Pimm Fox on Bloomberg Television's "Taking Stock."