It's Autumn. Is The Fall Coming?
As the days get shorter and the leaves change color temperatures will decline as winter approaches. This statement is not intended to be a depressing reminder of what is to come for those in northern climates nor is it meant to be a metaphor of what to expect in financial markets. However, moods do seem to be affected with shorter days and cooler temperatures. And mood swings are a real phenomenon in the investing world as well. The science surrounding behavioral finance is well researched. Its basic tenet revolves around the notion that as humans we tend to make poor investment decisions due to the heavy influence of our emotions. It is this concept that explains why bubbles develop. Inevitably sanity returns after a big rise in prices which is the downside of the boom-bust cycle.
As investment professionals we fight the urge to fall into this trap when making decisions on allocations. The news of the day or the latest investment craze may cloud even the best judgement. Investing takes not only knowledge and courage, but conviction too.
With the final quarter of the calendar year upon us it is an appropriate time to review current conditions and to evaluate where we may be headed. In the investment world ‘spring cleaning’ often takes place at the end of the calendar year as professional investors reposition portfolios for the year-end reporting season. Those who suffer from FOMO (fear of missing out) will buy up winning positions and sell under-performers to dress up portfolios.
This may aid vanity, but it seldom helps long-term performance. However, this seasonal phenomenon can benefit those willing to take the other side. If one is willing to sell (and presumably pay taxes on gains) the best performing investments and, conversely, willing to invest in the year’s poorest performers, they may find bargain priced entry points as tired and frustrated holders look to sell. At EPIQ, some of our best purchases have been initiated around the end of the year as bargains arise for non-fundamental reasons.
In reviewing economic data, we remain enthused about the long-term outlook for investors in risk assets such as stocks and remain guarded regarding fixed income instruments. Although current trends point to a slowing in economic activity this appears to be transitory in nature and related to the issues de jour (trade, BREXIT, Washington politics, etc.), rather than any underlying structural problems.
One area of concern we are monitoring is the repo (short for Repurchase and Reverse Repurchase) market. This is an obscure corner of finance where banks and other financial institutions use their assets as collateral for short-term financing. Trillions of dollars trade in this market daily in a secure and ho-hum fashion. Who participates in this market and how does it work?
Think of a money market fund (MMF) and a securities firm (SF). The MMF needs to invest cash overnight so it lends its liquidity to the SF and the SF needs the overnight liquidity, so it lends its Treasury bond, for example, as collateral to the MMF in exchange for cash. Supply (MMF cash) meets demand (SF loan), creating a win-win situation. The rate charged in the repo market is usually very close to the Fed Funds Rate, currently 1.75 – 2.00%.
At this most recent quarter’s end, however, rates reportedly shot as high as 10%. Liquidity had dried up and the Federal Reserve had to step in to provide what some consider to be emergency funding to meet market demand. Rates usually rise slightly over quarter-ends, but this was exceptional, and we are searching to see if this symptom is a potential sign of a greater systemic issue.
On a more positive note, improved clarity on regulation or policy should quickly restore confidence for businesses. This could lead to continued support for employment (unemployment at records lows) and sustain a strong consumer whose activity accounts for 70% of the domestic economy.
Today we enjoy low inflation, inexpensive capital (low interest rates) and cheap, bountiful energy. These attributes coupled with robust financial institutions underpin our constructive outlook for risk assets such as stocks and real estate.
We look forward to reporting back to you in the New Year. And, as always, please reach out to continue the conversation.
-EPIQ Partners
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EPIQ Happenings
- Missed this year's EPIQ Clambake? Listen to the entire discussion with Gene Munster and Jim Robillard HERE
- Check out Bruce's conversation with Finance & Commerce about the Angel Tax Credit and how we help clients invest in Minnesota startups.