Hello Everybody,
Today the ECB announced its largest quantitative easing program where it will buy about $1.157 trillion in bonds by the Fall of 2016. The plan is to combat deflationary pressures, bolster asset prices and stimulate the economy. The ECB had to make this move but the reality is that structural reforms must be made throughout Southern Europe or there are massive risks of political and social upheaval. Make no mistake, much of Southern Europe is in a depression, with youth unemployment of 50% in some countries. It is my belief that these easing programs across the globe have masked an underlying weakness in the economy in the U.S. and abroad. Very few structural changes have been made and those that have are likely to be long-term negatives for the economy. During the Great Depression, FDR instituted numerous infrastructure programs to boost employment particularly for the youth. It also increased asset prices, but of course it wasn’t until World War 2 that we really escaped the Depression. These types of programs have been noticeably absent and while unemployment has gone down, the quality of jobs growth is low and wage growth is nonexistent.
These quantitative measures have bolstered bond and stock prices to absurd levels in some cases. Bonds of strong credit quality offer paltry returns and huge interest rate risk. While stock indexes are not trading at the same obscene valuations of 2000, there are similar pockets where the valuations make no sense. Baby boomers in search of yield have flocked to companies such as Colgate, Coca-Cola and utilities and have pushed these slow growing companies to valuations that make no sense and considerable risk. Many of the stocks in the S&P 500 and the DOW appear overvalued and then there are also pockets of opportunity such as financials and energy. Healthcare stocks are incredibly expensive after a great 2014 but the growth is just not there to justify it. Similarly to the late 90’s, we’ve seen strong markets lift all boats, so many market participants have skated by and have little concept of the risks they are taking.
At TTCM we aren’t willing to play that game and chase valuations when they get extreme. By doing that and differing from the index, we are assuring ourselves of temporary periods of underperformance. As Buffett says, “it is only when the tide comes in that you see who has been swimming naked.” Our portfolios are built with stocks that are almost all trading below book value for example. These stocks have historically posted the best returns and have the lowest long-term risk profile according to many studies. We also really started focusing on selling long-term put options the last year and a half to ensure the maximum amount of protection in case of a market downturn. By January 2016, most of these options will expire and you’ll see the total impact on your portfolios as time value and volatility go to zero. The key is being patient and sticking with that value philosophy. Our goal is to avoid the next bubble and focus on maximizing risk-adjusted returns so now is not the time to get greedy in year of bull market. As always, we will keep you informed and if you need anything please don’t hesitate to contact me!
http://www.wsj.com/articles/ecb-announces-stimulus-plan-1421931011?mod=WSJ_hpp_LEFTTopStories