Investing in the World of the New Normal
First, a personal note…
My sincere thanks to all the Daily Reckoning readers who offered kind words about the untimely death of my cat, Uzi. I truly appreciate the emails – both from those who offered condolences and from those who merely appreciated this real-world illustration of asymmetric risk.
But since no other pets, family members or relatives perished during the last 48 hours, today’s edition of The Daily Reckoning will not impart any additional hard-life lessons about risk or reward. Instead, we’ll return to our usual diet of dispassionate analysis, co-mingled with skepticism, disbelief, bewilderment and/or pure panic.
In his latest investment commentary, Bill Gross, CEO of PIMCO, notes that long-time hedge fund manager, Stan Druckenmiller, is finally hanging up his (gilded) spurs. According to Gross, Druckenmiller’s retirement is “reflective of a broader trend in the capital markets, one which saw the availability of cheap financing drive asset prices to unsustainable heights during the dotcom and housing bubble of the past decade, and then suffered the slings and arrows of a liquidity crisis in 2008 to date.”
Gross asserts that “cheap financing” also fueled “lots of other successful business models over the past 25 years: housing, commercial real estate, investment banking, goodness – dare I say, investment management.” Druckenmiller, and his 30% annulized returns were merely one notable beneficiary of the Easy Money Era. But the easy money is gone…and so is Druckenmiller.
“The New Normal has a new set of rules,” Gross cautions. “What once pumped asset prices and favored the production of paper, as opposed to things, is now in retrograde. Leverage and deregulation are fading from the horizon and their polar opposites are in the ascendant. Some characterize it in biblical terms – seven fat years to be followed by seven years of lean. Others like Michael Moore and Oliver Stone describe it in terms of social justice – greed no longer is good. And the hedge fund guys – well, they just take their ball and go home…
“The unmistakable fact is that future investment returns will be far lower than historical averages,” Gross predicts. “There are all sizes and shapes of ‘investors’ out there who have not correctly visualized the lower return world of the New Normal.”
Gross does not name names, but he does single out pension plan managers for their failure to understand the New Normal.
Despite the fact that median annualized pension plan returns for the past 10 years have averaged 3%, most pension plan managers and consultants continue to assume 8% annualized returns in perpetuity. “Best of luck,” Gross scoffs. “The last time I checked, the investment grade bond market yielded only 2.5%,” which means that a 60/40 allocation of stocks and bonds “would require 12% from stocks to hit the magical 8% pool ball.”
Gross is skeptical…and so are the insiders of America’s largest public corporations. The latest ratio of insider selling to insider buying was 1,413 to 1. That’s not a typo. During the week ending September 24, insiders sold a whopping $417 million worth of company stock, while insiders purchased only $295 thousand worth of stock. Do the math.
Even if we were to eliminate the $233 million of Oracle shares sold by insiders, the ratio of selling to buying would remain a hefty 656-to-one – or nearly identical to the prior week’s ratio of 650-to-one.
Interestingly, finance company executives are conspicuously frequent members of the “Insider Selling” list. More than one year has passed since an insider purchased a single share of Citigroup or J.P. Morgan in the open market. More than 18 months have passed since an insider purchased a single share of Wells Fargo or Goldman Sachs in the open market. Meanwhile, dozens of insiders at these firms have sold shares during the last 18 months – raising billions of dollars in the process.
These remarkably large and lopsided insider transactions suggest that the Great Unwinding of the credit bubble may still have some unwinding left to do. Notwithstanding yesterday’s hoopla on Capitol Hill that Treasury’s Troubled Asset Relief Program (TARP) would lose “only” $30 billion – and the knock-on inference that the credit crisis has ended – the insiders at most of the largest TARP recipients are selling their stocks, not buying them.
The TARP owes its “success” to a flukey combination of dumb luck and large-scale market manipulation. That’s the “why” of the story. But the “what” of the story is that the TARP bought low and sold high. The insiders at most of the largest TARP-recipient firms have done, and are doing, the exact same thing.
Maybe these insiders are raising a little cash to pay their country club dues…or maybe they’re raising cash because the Troubled Asset Relief Program is winding down…even though the troubled assets are still hanging around.
“Deleveraging [remains] the fashion du jour,” says Gross, and meager stock market returns remain the likely outcome.
“Stocks are staring straight into new normal real growth rates of 2% or less,” Gross warns. “There is no 8% there for pension funds. There are no stocks for the long run at 12% returns. And the most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living. Stan Druckenmiller is leaving, and with good reason. A future of low investment returns, and a heap of trouble for those expecting more, is what lies ahead.”
Bill Gross said it; we merely thought it.