This note was originally published
at 8am on June 08, 2012.
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“We are comfortable missing out on potentially major rallies if they are based purely on money flows or government action; the risks of engaging in this sort of speculative activity are simply too high.”
I’ve always enjoyed reading the quarterly letters and writings of great investors. From my perspective, Baupost’s Seth Klarman fits into the category of a great investor. The quote above is from his Q1 2012 letter to investors. On some level, Klarman has earned the right to underperform in the short run as his long run track record, almost 30 years, is superior to almost any investor in that time frame.
That being said, I think what likely differentiates Klarman and many investors with superior long run track records is their process. My guess is that Klarman may have written the above quote even just a couple of years into his career before his track record was established.
The fact is great investors have a process. Sometimes the process tells them to invest aggressively, sometimes it tells them to stay on the sidelines with large cash balances, but the outcome of the process is a plan to allocate capital. Overtime, if the process is superior, the outcome will be positively differentiated returns.
If I were allocating capital to funds, the first question I would ask any potential manager would be - what is your process? That would be followed by - why will this process produce superior results over time? Undoubtedly after reviewing their historic results, I could determine whether they actually had a process and executed on their investment plan accordingly.
The famed Spanish painter Pablo Picasso said this about having a plan:
“Our goals can only be reached through the vehicle of a plan, in which we must fervently believe, and upon which we must vigorously act. There is no other route to success.”
Quoting a famed European artist about planning is somewhat appropriate given the current debacle in Europe. Now this isn’t a shot at Europeans but rather a shot at the lack of an actual long term plan emerging to solve Europe’s long run debt crisis. Not to mention, the lack of a long term plan when the common currency was established.
I’ve had a number of friends who are traders, either personally or for large institutions, email me over the last couple of days and the general consensus in the trading community seems to be that the market will remain choppy until after the Greek elections, the G20, the FOMC, and the EU Summit. Not to put words in their mouths, but the plan in the trading community seems to be to not do much until the central planners are done planning. I like that plan.
As we wait for the central planners to stop their planning, the economic data out of Europe continues to deteriorate. The key European economic data from the last 24 hours includes:
- German exports declining in April -1.2%, for the first decline this year (worse than expected);
- Bank of France cuts its forecast in Q2 for France to -0.1% (worse than expected);
- Italian industrial output for April comes in weaker at -1.9% month-over-month (worse than expected);
- Netherlands April industrial production comes in at -2.7% month-over-month (weaker than expected); and
- Greek GDP contracted -6.5% in Q1 from a year ago, versus the -6.2% projected decline on May 15th.
The most startling data point is likely the last one. Not because the Greek economy matters all that much anymore, but rather because the Greek government continues to have a difficult time getting a handle on the actual data. Personally, I’ve basically accepted that most governments make up the numbers, so revisions, either up or down, are really of no great surprise.
Speaking of government data, the Chinese government will be releasing a broad swath of data over the next 24 hours, including consumer price index, industrial production, retail sales, and producer price index. For many, the plan is to buy commodities and risk assets if a Chinese rate cutting cycle begins in earnest. In the Chart of the Day, you can see why this may not be such a good plan, at least according to the last cycle.
Specifically, on September 16th, 2008, China cut rates for the first time in the cycle. As might be expected the 19-commodity CRB index ripped +9.5% in six days. By March 2nd, 2009, the CRB index bottomed -46.4% lower. Chinese rate cutting may have been a panacea for some, though not for those investors levered long of commodities. (Thanks to my colleague Darius Dale for putting this analysis together.)
Certainly, risk assets may act differently this time around if China starts to cut interest rates aggressively. My point is simply that front running central planners, to Seth Klarman’s point above, is a dangerous plan, if it is a true investment plan at all.
Yesterday, Chairman Bernanke presented his plan to Congress and as part of that testimony he said:
“The Committee reviews the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”
This came at the end of the paragraph in which Bernanke outlined the Fed’s current actions, namely federal funds rate at zero for an extended period and a number of rounds of quantitative easing. In effect, via error of omission perhaps, Bernanke insinuated yesterday that the Fed is basically out of bullets. This might just be the best plan I’ve heard from the Federal Reserve in years.
Our key levels are: SPX fails at 1332 resistance (no support to 1283 TAIL); VIX holds 21.41 TRADE support, resistance = 24.73; USD holds all lines of support (range = 81.98-82.62); Euro fails, again, at 1.25 resist, support = 1.22; Oil (brent) fails at 101.73 TRADE resistance, no support to 95.26 (bearish formation there); and Gold has a big breakdown through our 1596 TRADE support, now nothing to 1538.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research