Who We Are
Published On: January 31, 2018
Written by: Ben Atwater and Matt Malick
To be a successful investor, you must follow a discipline. Doing so is easy in theory, but difficult in execution. Before we established our firm in late 2008, we penned an investment philosophy statement, which is the North Star of our discipline.
Today we want to share three key sentences from the philosophy:
“We consider the contrarian point of view in each investment decision that we make. When the stock market is gripped by fear and pessimism, we remain confident that stock prices will eventually reflect the long-term viability of the underlying companies. When the stock market experiences unjustified and excessive enthusiasm, we become cautious of overvalued stock prices.”
From 2009, as you can read in our book, The Disciplined Contrarian, we argued that equities presented compelling value as they climbed a wall of worry. About ten months ago, we became concerned about excessive valuations in stocks, all the while understanding that valuations themselves are a poor predictor of short-term market returns.
Today, we are convinced that “excessive enthusiasm” has now entered the fray. Although our list of anecdotes is substantial, the most compelling is fund flows. Analysts at Bank of America Merrill Lynch calculate that last week saw the most money ever flow into equities, $33.2 billion, $21.1 billion of which went into exchange traded funds and the balance into mutual funds. This boom coincided with the largest of the S&P 500 ETFs, the State Street SPDR S&P 500 EFT, swelling to $300 billion in assets.
These massive fund flows come as the market has experienced uninterrupted bliss. As of the Friday market close, the S&P 500 had gone 448 days without a 3% correction (longest streak ever) and 578 days without a 5% correction (second longest streak ever) in the midst of the second longest bull market in history. Until today, the market hadn’t seen two back-to-back down days of more than 0.5% for 350 days, the longest such streak ever.
In 13 of the past 15 years when the market has risen more than 5% in January, the year has gone on to see big gains. As a matter of fact, as of Friday, this is the best start to a year since 1987. This is also the worst start to a year for the U.S. dollar since 1987.
Momentum in markets is powerful. The vast majority of market watchers see the year continuing its positive trend, but we can’t help but be cautious of this enthusiasm.
One of our concerns (and this isn’t a prediction, rather an exploration of a risk), lies in the recent parabolic move in markets, the overuse of S&P 500 Index ETFs, the aforementioned lack of downside volatility and how these three factors could interact.
Many speculators are entering today’s market based on momentum and/or a fear of missing out and they are expecting large, consistent and quick gains. The “sophisticated” among these speculators – hedge funds – are surely hedging their exposure or at least defining levels at which to exit their positions if momentum breaks. Given the time period since even a 3% drop, many will surely have a hair trigger when we see a significant break in the trend.
Now consider the S&P 500 Index ETFs, the preferred instrument of many investors entering the market at this juncture. It doesn’t take much imagination to foresee a cascade of human and algorithmic selling of index ETFs given a 3% or even a 5% drop in the market. This kind of disorderly selling has the potential to quickly create unintended consequences.
To be sure, we have no idea how and when this will end. Rather, we caution against excessive enthusiasm. We urge you to consider the contrarian view and to make an honest assessment of your risk tolerance.
Please visit www.atwatermalick.com/ria for full disclosure materials related to recommendations contained in this update.
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